Markets: Diagnosing a bright future

It looks like investors are overjoyed by Sonic Healthcare’s acquisition of German laboratory business Labco. Sonic jumped as much as 2.3 per cent in early trade on news of the acquisition.

Although globally the population is ageing, government changes pose huge threats to the healthcare sector as they can blindside markets and investors. The healthcare sector has long been favoured by investors for its defensive characteristics, however with governments across the developed world looking to slash budgets, healthcare could be in the firing line.

Sonic, along with other players such as Primary Health and private-equity owned Healthscope  operate in an industry that is susceptible to government and policy change, something that is extremely difficult for investors to hedge against.

While a change to healthcare in any government budget would not be received favourably by the public, in a time where governments are trying to balance budgets it is not an impossible thought. It was only earlier this year US Congress approved a further four per cent adjustment to the usual Medicare fee schedule formula.

While the Medicare cut results in less than a one per cent reduction to this financial year earnings, it highlights the sensitivity of Sonic to such cuts. Fortunately for Sonic they only generate just on 20 per cent of their revenues in the US. An equivalent cut in Australia would have far more damaging effects.

Sonic’s acquisition appears strategically sound with strong opportunities for synergies to be realised throughout Germany.

On the numbers front, the transaction is tipped to be earnings per share accretive from the get go. This should help earnings per share to continue to grow – the financial year gone saw basic earnings per share only grow at 4.5 per cent.

Last year, Germany accounted for 16 per cent of Sonic’s revenue. The acquisition will give Sonic a more even spread of revenue generation, which will become increasingly important as global growth looks set to become more disjointed and less consistent across the developed world.

While the future looks bright for Sonic, it might be wise to hedge your bets and consider another healthcare player for diversification, like Primary Healthcare. If the numbers are right, Primary looks like it is snatching market share from Sonic.

A final thought: things could be interesting for Sonic if the yield on the Australian government 10-year bond falls from here. The past year or so has seen Sonic move in tandem with the yield.