Upgrades For Sonic

This story features SONIC HEALTHCARE LIMITED. For more info SHARE ANALYSIS: SHL

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By Chris Shaw

At its annual general meeting yesterday pathology group Sonic Healthcare ((SHL)) reiterated FY11 earnings guidance, which implies net profit after tax growth of 5-15% in constant currency terms. This guidance excludes the impact of any acquisitions made during the period.

According to RBS Australia, the update from management contained some good news, the most significant being signs of a recent uptick in pathology volumes have again been confirmed. As the broker notes, pathology volumes for Sonic for July to October rose 7.4%.

This was better than the 5.5% increase recorded by competitor Primary Healthcare ((PRY)) over the same period and implies some market share gains for Sonic. As BA-Merrill Lynch points out, it also implies the cycling of lower comparable numbers from a year ago, which should ensure the delivery of earnings in line with guidance, which could see a re-rating of Sonic's earnings multiple.

The significance of this improvement in pathology volumes, comments JP Morgan, is the leverage of Sonic's pathology business to the top line. This damaged earnings when volumes were under pressure, but now conditions are improving JP Morgan sees scope for a surprise to the upside from newly re-based levels.

Given Sonic has been able to capture additional operating synergies in its pathology operations, JP Morgan expects this leverage impact for earnings should be even more pronounced as volumes continue to tick higher.

Deutsche Bank is a little more cautious though, its concern being the rolling out of new collection centres, and Sonic is understood to have opened around 200 new centres since June, will lift costs to the extent the benefits of any volume recovery will be offset.

A major issue for Sonic remains risks related to the deregulation of the domestic pathology collection centre industry, Credit Suisse pointing out this process implies higher costs for Sonic and the other players in the market.

On the plus side, Deutsche Bank notes the relationship between the industry and government appears to have become a more consultative one, which increases the chance of a constructive funding outcome in the next Federal Budget.

In the view of Deutsche Bank, increased certainty with respect to government funding for the industry would be a positive for investor confidence, though a positive outcome in the near-term remains unlikely according to the broker.

Outside of Australia, Sonic's growth via acquisition plans in both the US and EU remain intact, the important point for JP Morgan being the company has achieved critical mass in its major markets. This should allow for the better capture of synergy benefits going forward.

Given earnings guidance remains unchanged post the annual general meeting, changes to broker earnings forecasts for Sonic have been minimal. Consensus forecasts in earnings per share (EPS) terms according to the FNArena database stand at 80.5c in FY11 and 89.4c in FY12.

Credit Suisse remains among the more conservative, its EPS forecasts standing at 75.1c for FY11 and 83.8c in FY12. The forecasts reflect the broker's view there remains downside risk to domestic pathology margins given the uncertainty surrounding whether volumes can improve enough to offset higher costs.

What has changed are broker ratings, with BA-ML, JP Morgan and Deutsche Bank all upgrading Sonic to Buy ratings from Neutral previously. For JP Morgan the upgrade is valuation based as relative to sector peers the broker sees standout value in Sonic now pathology volumes are rebounding.

The chance domestic funding uncertainty will be addressed in coming months is a factor in Deutsche Bank's upgrade to a Buy, while BA-ML also suggests Sonic appears well placed to be a beneficiary of any rationalisation in the Australian pathology sector.

Post the upgrades in rating, the FNArena database now shows Sonic is rated as Buy five times, Hold twice and Sell once, the latter courtesy of a still cautious Credit Suisse. The consensus price target for Sonic according to the FNArena database stands at $12.10, which is up from around $11.80 prior to the AGM update.

Shares in Sonic today are unchanged as at 11.40am with a last sale price of $11.25. Over the past year the stock has traded in a range of $9.53 to $15.64 and at current levels it implies upside of around 6% to the consensus price target in the FNArena database.

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