Sonic Healthcare (SHL). This morning, global pathology company SHL reported their first half of 2024 profit results, which came in below market expectations. These were an eagerly awaited set of results and the first to show a slowing down of PCR testing, which has offered rivers of gold for SHL, which the company has put to good use, expanding the business in the USA and Europe. The HNW Growth Portfolio has a 2.5% weight to Sonic.

Key Points:

  • Profits down: Half-year profits were down 47% to $202 million as very high-margin Covid testing rolled off the sales book, with Covid revenue falling by 89%; not a great surprise to us, but some on the sell side had this continuing. What was pleasing to see was that the base pathology testing business performed well, with revenue growing by 14% to $4.3 billion. This was supported by strong growth across all regions, particularly in Australia and the US. This growth is why we own Sonic, and since 1HFY2020 (pre-CV19 June to Dec 2019), the company has added $1 billion in semi-annual revenue via organic growth and acquisitions.
  • Inorganic Growth: During the half, Sonic spent $985 million on acquiring new pathology businesses across Germany, Switzerland, the UK and the USA, with these businesses expected to bring in $500 million in annual revenue once fully integrated, though this was not in this result.
  • Dividend: A modest increase of +2% to $0.43 per share in line with SHL’s progressive dividend policy with a payout ratio of 100%, supported by strong cash generation throughout the half.
  • Continued Balance Sheet Strength: Gearing increased to 19% with an interest cover ratio (annual profit divided by interest cost) of 19 times; there are no anxious bankers.
  • Outlook: Sonic management reaffirmed their guidance of FY24 EBITDA between $1.7-1.8 billion, reflecting a 5% increase on FY23 with the base business performance offsetting material reduction in COVID-related earnings.
  • Why is the stock down? The stock was down today as analysts overestimated the amount of Covid-related earnings the business would be able to hold onto outside of the pandemic, with Covid-related revenue falling by 89%. This seems like an overreaction, and we will look to add to SHL on further weakness.

Portfolio Strategy: Sonic and CSL represent the core healthcare positions in the Portfolio. SHL exposes us to rising demand for medical testing, exacerbated by new medical technologies, an aging population and a desire by doctors to cover themselves against malpractice claims by increasing the number of tests being ordered. SHL is one of the largest global patient testing companies with a significant market share in Australia, Germany, the UK and the USA and will benefit from a falling AUD. Unlike drug companies or device companies such as Cochlear, SHL has an industrial process of blood and tissue sample testing that benefits from economies of scale and not the hundreds of millions of dollars invested in R&D to develop the next wonder drug device.

In the medium term, SHL will benefit from an older and sicker population and doctors scheduling more tests to avoid malpractice suits, particularly in the USA, where SHL is now the third largest pathology company. Unlike many companies splashing around AI this reporting season with often dubious connections to their business, SHL is likely to see significant benefits from digital pathology and AI. The company has made substantial investments in this area in the past two years, starting with a prognostic AI algorithm for melanoma.

SHL finished down -8% to $29.24

Base business (cake) is growing, CV-19 testing (icing) is shrinking as the pandemic subsides