Sonic Healthcare (ASX:SHL) has seen a doubling of its share price in the last 5 years. We determine whether weakness in the last few days represents a new buying opportunity.
Overview of Sonic Healthcare (ASX:SHL)
SHL is the world’s third largest provider of pathology/clinical laboratory services. It has a presence in the laboratory markets of eight countries. SHL is the largest private operator in Australia, Germany, Switzerland and the UK, the second largest in Belgium and NZ and within the top five in the US.
SHL released their FY17 results in August 2017. The underlying results were in line with guidance, but below market expectations. This was due to adverse foreign exchange movements and non-recurring items.
The result was driven by solid organic revenue growth in the Laboratory (+6%) and Imaging (+5%) divisions. They drove underlying earnings (+8% in Laboratory and +7% in Imaging) and improved margins, +25 basis points and 30 basis points, respectively. These gains helped to offset ongoing softness in the Clinical Services division (which is due to Medicare fee indexation freeze). It also kept operating margins flat (17.4%).
SHL is currently trading on a 1-year forward P/E multiple of ~20x, which is broadly in line with recent trends. We do not consider this to be an attractive metric relative to the earnings growth profile.
Adjusted for the expected impact on EBITDA from the CMS cuts, the effective EBITDA growth guidance for FY18 of 5-7% is broadly in line with the 5.3% reported for FY17.
Further acquisitions are needed to support the longer-term EPS growth profile. This is given that organic growth rates, which range between 3-5% for the key operating divisions, is hardly exciting. Recent acquisitions are likely to account for the majority of EBITDA growth in FY18. Notwithstanding that there is sufficient balance sheet capacity, any further acquisitions are likely to be debt-funded, placing further upward pressure on gearing levels.
In terms of the potential for higher organic growth, SHL has recently completed an extensive expansion/upgrade of laboratory facilities around the world. This will provide additional headroom for organic growth.
Chart for Sonic Healthcare (ASX:SHL)
What is clear to us with the SHL chart is the formation of a large “rising wedge during the last two years. You will notice that the stock fell out of this wedge and is now hugging the underneath of it. This is interesting from a charting point of view. As SHL retests this line of resistance, it needs to push above it fairly soon for the chart to look bullish. Otherwise any further weakness here will be telling us that now is not the time to buy SHL. Weakness here will indicate that SHL will trade to the bottom of the rising wedge. That implies levels back near $17 can be seen during 2018.
Michael Gable is managing director of Fairmont Equities.
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