Integral Diagnostics Charts Strong Course In FY16

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-Supportive ageing demographics
-Attractive specialist model
-Strong presence on Gold Coast 
 

By Eva Brocklehurst

Growth prospects in Australia's diagnostic imaging industry are solid, brokers contend, and several have initiated coverage of the new kid on the ASX block, Integral Diagnostics ((IDX)).

The company's outlook is supported by an ageing demographic, requiring more diagnostic intervention in health care. Around 50% of procedures are performed on persons over the age of 55. As training periods are lengthy, qualified personnel are in short supply but brokers maintain the company's specialist model is conducive to attracting and retaining radiologists.

Morgan Stanley estimates 5.0% industry volume growth will continue in 2016 and Integral's shift to high-end imaging should enable its top line to outpace volumes, with 6.0% growth envisaged. The broker expects earnings margins should increase by another 50 basis points in FY16.

Long-term discounted cash flow is considered the most relevant valuation methodology for the business and Morgan Stanley initiates with an Overweight rating and a $2.15 target. There is some regulatory overhang from the Medicare review but the broker considers this accommodated in the share price since the IPO a month ago.

The company services the medical community through 44 sites including 12 hospitals. There company has three main brands, Lake Imaging in Victoria, South Coast Radiology in Queensland and Global Diagnostics in Western Australia.

Primary Health Care ((PRY)) is considered the next largest competitor in these regions. The market is fragmented and brokers envisage opportunities for consolidation, with the top five accounting for just 44% of the market.

Risks centre on contract expiries – although Integral's typical hospital contracts are at least five years – and changes to government funding. Brokers note increased government scrutiny of expensive Magnetic Resonance Imaging (MRIs). Regardless, conditions are expected to remain supportive of the industry.

Reports suggest diagnostic imaging can help shorten hospital stays and reduce the cost burden. Morgan Stanley also cites disease specific studies, which have found that increased imaging could elicit savings in the treatment of stroke patients, while CT scans have been found to reduce the rate of unnecessary appendectomies and hospital admissions.

The company has a well credentialled team and a model, brokers observe, whereby 54% of radiologists have equity in the listed vehicle, a combined 30% shareholding. This is subject to a staged escrow arrangement.

UBS estimates the company will achieve a 3-year trailing revenue growth rate of 7.2% and an earnings growth rate of 22.3%. The broker also notes the diagnostic imaging is the most capable segment in terms of levying patient co-payments. UBS is of the view the sector will revert to higher co-payments to offset any impact from reform or demand.

UBS believes the Medicare review only carries “sentiment” risk and no fundamental change to the diagnostic imaging proposition. The broker initiates coverage with a Buy rating and $2.30 target.

One of the main attractions for Credit Suisse is consistent growth in the sector over an extended period of time, with industry growth in revenues at a compound 7.2%. However, growth has pared back in FY15, with IBES estimating system growth of 5.5% and this softer growth has continued into FY16.

Despite valuation support and the favourable funding environment and demographics, Credit Suisse is inclined to initiate with a Neutral rating and $1.95 target. The broker contends that industry growth has been weaker in recent months amid the overhang of the Medicare review.

While aware of placing too much emphasis on monthly Medicare data, the broker does believe the market needs to stabilise and there is the potential for softness to continue in the short term. Credit Suisse acknowledges that 48% of revenue is non-Medicare and the company has an overweight presence in locations with an ability to levy co-payments, so pro-forma guidance for growth of 6.0% remains reasonable.

Specifically, Integral is overweight in Queensland, with that state accounting for 45% of revenue. Moreover, the focus is largely on the Gold Coast and that region, supported by tourism, appears to have the strongest economic outlook over the next three years.

Integral is also overweight in terms of hospital/specialist referrals, with 46% of its revenue derived from services rendered in hospitals, a supportive factor in Credit Suisse's opinion. Industry feedback has suggests GP referrals to diagnostic imaging are the main source of market weakness, with many suggesting the softness stems from changed referral patterns.

Credit Suisse also believes the company is well placed to participate in market consolidation, with few competing buyers in terms of scale. Integral could deploy up to $140m in capital and derive earnings accretion of over 25% with gearing not exceeding twice earnings.

Integral is adding two MRI machines to hospital sites in FY16. The two are expected to contribute a combined $1.45m in revenue in the second half of FY16 and 0.9% growth to the group.

FNArena's databases shows two Buy ratings and one Hold. The consensus target is $2.13 which suggests 18.2% upside to the last share price. Targets range from $1.95 to $2.30. The dividend yield on FY16 forecasts is 3.4% and on FY17 5.4%.
 

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