In Brief: Pro Medicus, Trump’s Trade War & Resi Construction

This story features PRO MEDICUS LIMITED, and other companies. For more info SHARE ANALYSIS: PME

Aggressive new target price for Pro Medicus; fears of a new Trump-inspired trade war; the best REITs for falling interest rates; and lagging starts figures for residential construction.

-Big new target for Pro Medicus
-The possibility of another Trump-inspired trade war
-Preferred REITs for falling interest rates
-Gloomy outlook for residential construction

By Mark Woodruff

Pro Medicus Adds US Military Potential

While some investors may feel left behind after a withering share price rise, new broker research suggests there may still be time to climb aboard the Pro Medicus ((PME)) juggernaut.

Yesterday, shares in the provider of medical imaging technology closed at $108, up from around $74 just over five months ago and $35 at the beginning of 2021, yet Evans and Partners has now set a new target price of $152.68, well above other brokers.

The company itself has secured certification to allow targeting of the US military health market, prompting the analysts to forecast an extra 5% share of the US radiology image viewing market by 2030, bringing the total expected share to 25%.

The Federal Risk and Authorisation Management Program (FedRAMP) certification is government-wide and promotes the adoption of secure cloud services across the US federal government by providing a standardised approach to security assessment, authorisation, and continuous monitoring for cloud products and services.  

Management at Pro Medicus has chosen not to announce on the ASX the receipt of FedRAMP High certification status.

There are two arms of the US military health system: the Military Health System (MHS) which operates within the Department of Defense to provide care to those on active duty and some retirees; and the Veteran Health Administration (VHA) which is part of the Department of Veteran Affairs and exclusively treats veterans/older cohorts. 

As an illustration of size, the VHA comprises 172 medical centers and 1,138 outpatient sites, making it the largest integrated health care system in the US.

The combined 9.6 million members of the VHA and MHS account for more than 30% of the total US market (by image view volume), and could be worth up to US$500m a year, according to Evans and Partners, which notes tendering for image Viewer contracts is imminent.

Unlike Pro Medicus, none of the main picture archiving and communications systems (PACS) incumbents in the US military health system -AGFA, Philips, General Electric and Siemens- have a truly scalable cloud solution, observes the broker.

However, political considerations are at play in US government decision making, caution the analysts, and Pro Medicus has partnered with various contractors with relevant connections and expertise.

Evans and Partners identifies several other areas of growth for Pro Medicus.

Management remains confident AI will eventually add to the revenue pie and has approached the opportunity from two angles: usage of the technology behind the scenes to improve its product offering; and as a discrete offer to customers, be it algorithms developed in-house or via collaboration (e.g. breast density) and/or by utilising algorithms from third parties. 

While the analysts add 5% to each forecast contract for Pro Medicus from FY26 onwards to allow for AI, diagnostic algorithms will only become part of the service rather than a major new revenue line, in the broker’s opinion.

In time, customers may also expand contracts to include Archive and Worklist components. Currently, the analysts believe the break-up contract value is split between Viewer, Archive and Worklist by around 60%, 25% and 15%, respectively.

Pro Medicus has also noticed an uptick in enquiries from the corporate sector in recent times, with many joining forces under affiliate arrangements and looking to upgrade systems, explains the broker.

The average target price of five brokers covering Pro Medicus in the FNArena database is $78.90. If the $34.50 outlying target set by Ord Minnett is excluded, the average of the remaining four brokers is $90, well adrift of the $152.68 target set by Evans and Partners.

Worried about another Trump-inspired trade war 

The potential for another intense trade dispute between the US and China should Donald Trump become the next US President is beginning to unsettle some global investors, according to investment manager Western Asset.

Disruption may ensue for global growth, financial markets, and supply chains, in the event the new administration pursues aggressive tariff measures against China and other trading partners, suggests Western Asset, part of US-based Franklin Templeton Investments.

According to Robert Abad, product specialist at Western Asset, “another trade war at this juncture in the global macroeconomic cycle, especially one that significantly affects China's growth prospects, could reignite fears of a global recession and raise concerns about the potential inflationary consequences of higher tariffs.”

In 2018, global financial markets were blindsided by the government’s decision to launch a trade war with China and multiple US allies. 

The US equity market experienced a -$1.7trn loss in market value at the height of US-China trade tensions in mid-2019, notes Western Asset, and at the peak of the trade war in 2018/19, China's quarterly gross domestic product was negatively impacted by as much as -0.8%.

During this period, developed market government bond yields also declined sharply as investors contemplated major central banks implementing more aggressive rate cuts to counteract global growth risks.

Concerns also emerged about a global currency war, notes Western Asset, with the Chinese yuan depreciating to a level not seen since the 2008 global financial crisis, precipitating a selloff in emerging market equity and currency markets.

Thankfully, there are two factors mitigating against such a volatile reaction this time around.

Robert Abad notes markets may be partly inured to formerly-alarming impromptu announcements by Trump on social media. Also, governments and corporations worldwide have put in place contingency plans to manage global trade and supply-chain disruptions via near shoring strategies.

Rather than dwell upon inflationary impacts of a Trump presidency, Abad believes the more critical point to emphasise is the adverse impact tariffs could have on aggregate demand and long-term growth.

Charter Hall for falling interest rates

If history is any guide, Morgan Stanley suggests investors should be positioned in Charter Hall ((CHC)) and/or Dexus ((DXS)) to take advantage of an expansion in valuation multiples when long-term bond yields decline.

The Australian Real Estate sector has traditionally been regarded as a bond proxy because of the long-duration nature of assets and the strong focus on dividend yield, explains the broker.

The Australian 10-year bond yield fell to 0.8% in 2020, and then reached 4.95% on November 1, 2023, and has traded within a 3.9%-4.3% range over the last three months.

Asset devaluation concerns may be easing, suggests Morgan Stanley, with the spread between asset capitalisation rates and Australian 10-year bond yields now broadly in line with the long-term trend.

From among the ASX100 REITs, Charter Hall has the strongest, and the most consistent negative correlation to Australian 10-year bond yields, note the analysts, while Dexus shares also trade in a close relationship with the long-end of the rate curve.

Leaving aside negative correlations and returning to fundamentals, property fund manager Charter Hall is Morgan Stanley’s preferred exposure as it receives an immediate positive impact on earnings from yield compression/rising asset valuations.

The broker explains earnings for Dexus are more driven by passive rental income, and operational cash earnings could potentially remain flat even if asset valuations trends upwards.

Morgan Stanley has an Overweight rating and $13.25 target for Charter Hall. The average target of five covering brokers in the FNArena database is $13.94, suggesting just over 11% upside to the latest share price.

The broker has an Underweight recommendation for Dexus with a $7.65 target, while Macquarie has an Outperform rating and three other brokers in the database are on Hold, or equivalent. The average target for Dexus is $8.55, around -13% shy of the current share price.

No respite for residential construction in Australia

Residential construction starts remain near the lowest level since 2012 and activity is clearly moderating, observes Jarden, with little sign of near-term improvement.

The broker holds this view even though December quarter numbers showing residential starts lifted 1.3% quarter-on-quarter to an annualised pace of 154,000. 

Despite a surge of migration driving a record gap between underlying housing demand and supply, the broker believes housing activity will remain subdued through 2024.

Jarden is forecasting a more than -200,000 (or -20%) shortfall against the Australian Government’s 1.2m housing target over five years, which commences from July 1 this year.

As housing affordability is the biggest constraint on new housing activity, Jarden sees is limited upside until interest rates fall and buying power lifts.

Participants in the new housing market are generally skewed towards younger, middle-income first homebuyers, as opposed to the established housing market driven by higher-income buyers, explains the broker.

On the flipside, non-residential construction remains a source of strength, with the pipeline supported by public spending, non-residential building and mining/energy investment of $79bn, $70bn and $32bn, respectively.

While residential developers and building materials companies may be at risk from slowing residential construction, Jarden points out industry structure and consolidation are supporting incumbents. 

In addition, the recent surge in migration should support earnings from FY25 onwards once interest rates fall and affordability improves. Earlier or larger-than-expected RBA rate cuts remain the key upside risk to the broker’s outlook.

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