Australia | Jul 17 2006
By Chris Shaw
The likely loss of about 50% of its revenue from the New Zealand market thanks to a key contract being awarded to a competitor is obviously a negative for Sonic Healthcare (SHL), but not enough for brokers to change their positive opinion on the stock’s prospects in the longer-term.
The revenue loss, worth about $65m next year and as much as $75m in FY08, stems from the loss of the company’s pathology contract in Auckland, which has been awarded to a consortium whose members include competitor Healthscope (HSP).
Most market participants are somewhat confused by the decision to take the contract away from the incumbent, as JP Morgan among others notes Sonic remains the only company to have the required infrastructure in place to fully service the market and a competitor is unlikely to have the facilities in place by the time the new contract starts. They can’t expect Sonic to help them in this regard, Merrill Lynch suggesting the company is more likely to close its facilities than sell them to the new consortium.
Given this, and the fact Healthscope’s bid was below the level Sonic indicated represented its level of operating costs, leads the broker to suggest either Healthscope has agreed to accept losses on the contract or the contract it has is somewhat different to the one Sonic previously held. Both Merrill’s and JP Morgan expect Sonic will challenge the ruling, so a final resolution may take some time.
The brokers point out the loss of revenues and hence earnings is not a major blow for Sonic, as on JP Morgan’s numbers the earnings per share impact is about 4% in FY08. It is estimating EPS that year of 77.5c, while ABN Amro has reduced its forecast by 4.1% to 76c. ABN and JP Morgan have also made similar cuts to earnings estimates for FY09.
ABN Amro continues to rate the stock as Buy, though its price target has been reduced to $15.60 from $16.20 to reflect the lower earnings forecasts. Merrill Lynch also continues to rate the stock as Buy and has a $16.30 price target, suggesting any significant weakness on the news would represent a good buying opportunity. JP Morgan’s price target is even higher at $16.80 but it rates the stock as Neutral.
Yes, we are a bit puzzled by the differences in targets and recommendations as well.
The brokers agree the real area of importance to the company going forward is the securing of more pathology contracts in Europe and the US and the synergies such deals would generate, so while the New Zealand situation is a negative it doesn’t change the group’s longer-term growth prospects. ABN Amro suggests the company may in fact re-examine its commitment to the New Zealand market in light of the contract loss, as with its current hub-and-spoke industry model the loss of the central contract has implications for Sonic’s business model in that market.
Opinion on the stock is split, the FN Arena database showing the company is rated as Buy by four brokers and equity researchers while the same number consider it a Hold. The average price target is $16.28 compared to the median price target according to Thomson One Analytics of $15.17, which is based on a median forecast for earnings per share of 79c in FY08.
Sonic Healthcare shares have traded in a range of $12.15-$16.12 over the past 12 months, the stock currently trading down $1.15 at $12.35. This is below JP Morgan’s valuation assuming no further acquisitions of $12.85, an assessment that rises to $15.74 assuming acquisitions generating $60m in revenues and $6m in synergies annually.