Sonic Healthcare: Result 2015

Pathology network Sonic Healthcare received a blow this year when Alberta Health Services decided against offering the company an exclusive 15-year contract, despite choosing Sonic as its preferred pathology provider late last year. The contract would have added C$200m (A$208m) a year in revenue, required little capital expenditure, and was also expected to provide a platform for other provincial contract wins. It was a significant loss.

Pleasingly, though, revenue from the Australian operations – Sonic's largest division, accounting for 28% of total revenue – increased 5% for the year to June. That's a decent result given the overall Australian pathology market grew just 0.8%, which implies the company took market share.

However, this unfortunately didn't translate into growth in earnings before interest, tax, depreciation and amortisation (EBITDA), which was slightly negative. The poor result was attributed to higher infrastructure costs and the Federal Government's decision to cut Vitamin D test rebates by 9% in November 2014 as part of a widespread effort to rein in the healthcare budget.

While it's not the end of the world for a company that earned $4.2bn in revenue for the year (up 7.3%), as prices decline so too do margins. Sonic has high fixed costs due to the machinery and staff required to run the labs so as revenue falls, profitability falls more. Management said another fee cut is due in November.

The company's US division had organic revenue growth of just 2%. This was also due to Medicare fee cuts, which we expect to be an ongoing issue given the US healthcare budget is under even greater pressure than the Australian one. However, Sonic has completed a large restructure of the US business, which it believes has resulted in US$10m or more in annual savings.

Sonic's European operations performed well, with 11% revenue growth in Germany, helped by a few acquisitions, 25% in the UK, and 5% in Switzerland. Sonic will move into a new laboratory in central London early next year in preparation for a 10-year contract to provide pathology services to the National Health Service. The contract is expected to start next April and generate £50m (A$107m) a year in revenue. Sonic also purchased a collection of 10 laboratories in Switzerland, which it expects to add CHF160m (A$224m) in revenue. However, the deal was completed in July after the 2015 financial year-end.

Management expects revenue and earnings growth of 20% in 2016 as a result of acquisitions, new contracts and a lower Aussie dollar. Sonic's share price is up 9% since Sonic Healthcare: Interim result 2015 from 18 Feb 15 (Sell – $19.15). We intend to review the company in detail after reporting season, but for now we're sticking with SELL.