Sonic Healthcare: Interim result 2019

'I cannot stress enough the magnitude of the market in the US', said chief executive Colin Goldschmidt. 'And how big the opportunity is for Sonic with its medical leadership model so deeply embedded and now with this large Aurora acquisition and 220 pathologists.'

The excitement was palpable in the investor briefing. In January, Sonic bought US-based anatomical pathology provider Aurora Diagnostics for US$540m ($750m). Sonic had a good six months, but Aurora was seemingly the only thing investors wanted to talk about.

In 2020, the US will become Sonic's largest division - and it's 'very likely to stay there', as Goldschmidt said. The US market is mostly a collection of small independent pathology labs - no provider has more than a 5% share - whereas in Australia, Sonic and Healius control 76% of the market. That gives Sonic a smorgasbord of potential acquisition targets and many opportunities to combine and centralise labs, cutting costs in the process.

Aurora has joined Sonic's US division during one of its strongest financial halves in years. The US division increased revenue 8% in the six months to December after removing the effect of currency fluctuations and acquisitions. Management said this was 'well above market', suggesting the company increased its market share, and the result was driven by new hospital joint ventures and additional revenue from an improved billing system.

Medicare changes and fee cuts were introduced in January, but management said they would have only a minor effect on revenue of no more than 1.3% in 2019. Given the ongoing healthcare budgetary pressure in the US, fee cuts have been the norm for a good five years, so a year of pause is welcome. 

Australian growth

Total revenue rose 9% to $2.9bn, with the Australian division producing impressive organic growth of 6% excluding acquisitions. A big contributor was the Government's National Bowel Cancer Screening contract - pulled from Healius's grip last year - and earnings and margins for the Australian division improved due to Sonic's fixed costs and economies of scale. 

Since 2010, rents for collection centres rose dramatically, which reduced earnings growth for the division. We were glad to hear management say rents are now stabilising, which bodes well for future earnings growth. 

Sonic's European operations performed well, particularly its Swiss business where organic revenue growth was 5% due to strong underlying demand for pathology services. 

In Germany - Sonic's third largest division - revenue was flat at an underlying level due to a European heat wave and regulatory changes, although it grew 3% after acquisitions. Management said there was an 'active pipeline of further acquisitions' in Germany and - at the right price - they should add value for shareholders due to the significant economies of scale associated with pathology testing. 

Organic revenue was also impressive in the UK and Ireland, rising 9% due to strong growth in the private market and a large hospital contract. The Belgian operations produced flat organic growth, again impacted by the European heat wave but, at just 2% of total revenue, Belgium barely moves the needle anyway.  

Outlook improves

Net profit increased 7% to $223m, while free cash flow rose 2% to $199m. Net debt fell from $2.5bn to $2.1bn; however, this was due to the $600m capital raising to fund the Aurora acquisition, which only closed in January. Excluding that acquisition funding, net debt rose $108m. 

Management said that Sonic had achieved its 2019 earnings guidance after just seven months of trading. Management now expects EBITDA growth of 6-8% in 2019 - or roughly 3-5% excluding Aurora.

This was a great result for Sonic and we're glad to see earnings being powered by organic growth in the company's core markets - the smart acquisitions are a bonus. Sonic is now the largest pathology provider in four countries and the third largest in the US, with substantial economies of scale to help maintain that dominance.

The stock trades on a forward price-earnings ratio of 20 based on consensus estimates for 2019 earnings and the share price has risen 11% since we upgraded it to Buy in November. We're increasing our Buy price to $24 and our Sell price to $36, and we're hopeful of another buying opportunity, but for now the stock remains a HOLD.

Disclosure: The author owns shares in Sonic Healthcare.

Note: Our Model Growth and Model Income portfolios own shares in Sonic Healthcare.