Sonic downgraded to Sell
Recommendation
Sonic Healthcare's share price has been on a tear since the company was chosen in October to enter an exclusive due diligence period with Alberta Health Services to provide pathology services in Edmonton, Canada. The 15-year contract is expected to generate CA$200m a year in revenue and be finalised in early 2015.
Management didn't provide details of how the contract would impact net profit, but at Sonic's historic profit margin of around 9–10% it could add up to $20m a year to the bottom line – around 5.0 cents per share. Still, given the intensity of competition for large contracts with other providers, such as Mayo Clinic and Alberta incumbent DynaLIFEDX, we wouldn't be surprised if the margin was below average.
This is Sonic's first foray into Canada and winning the Alberta Health contract would provide a sturdy platform for other provincial contract wins. Nonetheless, Canada is a mature pathology market and we expect organic growth to be similar to Australia's long-term rate of 5%.
Sonic's share price is up 8% since Sonic Healthcare: Result 2014 from 20 Aug 14 (Hold – $17.62) and 65% since we initially upgraded the stock on 5 Aug 11 (Long Term Buy – $11.47). Sonic is a high quality company and we expect it to be bigger and better ten years from now. However, an enterprise value close to 17 times operating earnings and current PER of 20 means you're already paying for that growth, leaving little room for error. It's hard to let go of Sonic, but there are better opportunities on our Buy list. SELL