Views Differ On Sonic And Healthscope

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This story features SONIC HEALTHCARE LIMITED.
For more info SHARE ANALYSIS: SHL
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

New Zealand is something of a battleground at present for Sonic Healthcare ((SHL)) and Healthscope ((HSP)) given an ongoing dispute over a pathology contract in Auckland. Uncertainty over the outcome of the disagreement is contributing to a divergence of broker views with respect to the two stocks.

As it stands at present, Healthscope has been successful in its appeal in relation to a contract with the Auckland Region District Health Board. The NZ Court of Appeal has taken the view the company should have taken over as the service provider, which reversed a NZ High Court decision from 2007.

Sonic is currently the provider via subsidiary Diagnostic Medlab, and on GSJB Were’s numbers, the contract represents about 3% of group revenue and EBITA (earnings before interest, tax and amortisation) this year and while this is not overly significant, the broker expects the company will appeal the latest decision.

The decision has already had some impact on the respective relative share prices of the two companies, with Sonic down more than 10% over the past month and so performing much worse than Healthscope. This has prompted Merrill Lynch to reassess its ratings, with the broker upgrading Sonic to Neutral from Underperform on valuation grounds and downgrading Healthscope to Underperform from Neutral.

With respect to the former, the broker notes the stock is now trading 17% below its valuation and so offers improved value, especially when there is as much as $310 million available to management with which to grow earnings via acquisitions.

Offsetting this is some concern over how the group will fund its pathology business given expectations of more cuts in the 2009 Federal Budget, but overall the stock is a more attractive proposition, in the broker’s view, than was recently the case.

In contrast, the broker suggests Healthscope has only around $70 million with which to pursue growth options and this is likely to generate only incremental earnings growth at best in its view. As with Sonic, regulatory concerns remain an issue for the company and so on balance there is only limited upside from current levels in Merrill’s view.

In contrast, GSJB Were sees good value in Healthscope at present, as on its numbers the stock is trading on a P/E (price to earnings) multiple of just 14x. This is despite the company offering the prospect of double digit earnings per share (EPS) growth in coming years. The broker is forecasting EPS 34c this year and 38.8c in FY10, which is close to the Merrill Lynch estimates of 35.2c and 38.6c respectively.

Where the broker’s do agree is with respect to the outlook for Sonic, as GSJB Were also rates the stock as a Hold at present, estimating if the final court decision were to go against the company it would have a minor negative impact on earnings compared to current forecasts. This uncertainty with respect to earnings is therefore not worth paying up for given the stock is on a forecast P/E of a little over 16c in FY09, making it more expensive in comparison to Healthscope.

The rest of the market doesn’t entirely agree though, as the FNArena database shows Sonic as rated Buy six times, Accumulate once and Hold three times compared to Healthscope at Buy twice, Hold six times and Sell once. The former has an average price target of $16.67, while the average target for the latter is $5.04.

Today, shares in the two companies are slightly stronger and as at 12.35pm Healthscope was up 7c at $4.70, while Sonic was 12c stronger at $13.50.

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