Australia | 10:00 AM
New research coverage on Sonic Healthcare suggests better times are ahead, supplemented by new technologies including artificial intelligence and genetic engineering.
-After five years of disappointment, new research suggests Sonic's future looks brighter
-Growth and margin improvement further boosted by AI & genetic testing
-Increasing efficiency via Franklin.ai and PathologyWatch
-Bell Potter sees 110bps of margin upside across FY25-27
By Mark Woodruff
Loyal shareholders in global healthcare services provider Sonic Healthcare ((SHL)) have had little to be excited about in the post-covid years. The share price surged to an all-time record high above $47 in 2021 (when societal lockdowns coloured the overall environment) but it has subsequently embarked on an elongated slide south that has pulled the price back to the mid-$20s.
Underlying, relentless margin pressure has pulled back the company's earnings per share to a pre-covid level, hence it seems but appropriate to see the share price equally at a pre-2020 number.
Cold comfort, no doubt, for those shareholders, but Sonic Healthcare's challenges have been mimicked by most of its peers across the healthcare sector globally. In Australia, previous can-do-no-wrong stalwarts such as CSL ((CSL)) and Cochlear ((COH)) have presented their shareholders with similar underwhelming performances, and let's not even mention Ramsay Health Care ((RHC)) or Healius ((HLS)).
But that was then, and the past does not necessarily provide investors with a blue print for the future. New research by Bell Potter suggests those suffering loyal shareholders in Sonic Healthcare might soon have something to smile about.
In initiating coverage yesterday, the broker points to macro-economic drivers such as population ageing, rising healthcare expenditure, advancing medical technologies, and growing demand for personalised and precision medicine as key tailwinds for the industry.
In Sonic's case, the research notes demand is also being driven by the normalisation of core operations post-covid, the integration of FY24 acquisitions, and business restructuring aligned with shifting volume patterns.
A cornerstone of Sonic's growth strategy remains its consistent acquisitive expansion, having taken over around 100 businesses globally to become the largest pathology provider in Australia, Germany, Switzerland, and the UK, and the third largest in the US.
Recent investments in automation, artificial intelligence, and operational scale are expected to deliver incremental efficiencies and underpin margin improvement.
While AI's transformative impact is still emerging, Bell Potter considers Sonic the most advanced AI-integrator in its coverage and believes current earnings expectations may underestimate the company's future potential.
Business split
Pathology operations in Australia, Germany, and the US accounted for approximately 65% of group revenue when Morgan Stanley initiated its own research coverage in March. In total, Pathology accounts for 85% of group revenue.
Since entering the US pathology market in 2005, Sonic has completed around 19 acquisitions, yet its expansion has remained regional rather than nationwide.
The US pathology landscape remains highly fragmented and offers ongoing acquisition opportunities, though competition from dominant national players, namely Quest Diagnostics and Laboratory Corporation of America, remains intense. The difficult operating environment prompted the analyst at Ord Minnett to suggest management should consider divesting its US assets.
Domestically, Sonic is also Australia's second-largest radiology provider by revenue (10% of group revenue). It also operates a clinical services arm, Sonic Clinical Services, which generates around 5% of group revenue.
Clinical Services partners with over 2,000 general practitioners across 200 medical centres and delivers services spanning general practice, occupational and remote health, aged care, and clinical trials.
Margins and AI
A suite of technologies is now being invoked by management to improve both operational performance and efficiency, which Bell Potter anticipates will flow through to margins over time. Two recent examples include Franklin.ai and PathologyWatch (more on these later).
Morgan Stanley sees three core drivers for healthcare AI adoption: revenue enhancement through improved diagnostic yield; cost reduction via more efficient development processes; and better workforce utilisation.
Management at Sigma notes prior margin compression was due to post-covid normalisation and inflation, but Sonic is now considered well-positioned for expansion through labour optimisation, operating leverage, and digital efficiencies.
Bell Potter agrees, anticipating 110bps of margin improvement between FY25-FY27.
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