Sonic Healthcare Limited (Sonic, the Group, ASX: SHL) is one of the world’s largest medical diagnostics companies that provides laboratory services (85 percent of revenue) and radiology services (10 percent) to doctors, hospitals, and their patients. Last year the Group serviced an estimated 125 million patients. Sonic was listed on the ASX in 1987 and today employs 42,000 people, including 1,600 pathologists and radiologists, and 15,500 medical scientists, radiographers, technicians and nurses, making it one of the world’s leading healthcare providers.
Synergistic acquisitions transitioning to future earnings growth
Sonic Healthcare has a proven history of expanding through acquisitions over many years, and now has strong positions in the laboratory markets of several countries, making it the world’s third-largest pathology services provider. Acquisitions in Germany, Switzerland, the UK and USA plus new contract wins in FY24 are estimated to generate about A$700 million in additional annual revenue from FY25. Full-year realisation of synergies from these acquisitions should occur in FY26 which will see significant EBITDA margin expansion in that year.
In the interim period EBITDA margin is moving higher, averaging 17.1 percent in the first half-year of FY24, rising to 18.6 percent in the second half-year. This is below the 20.9 percent EBITDA margin achieved in FY23 on 6.3 percent lower revenue. Strong revenue growth, lower labour costs and easing inflation rates should see this margin improve in FY25 and move higher again in FY26.
Labour costs as a percentage of revenue declined from 49.6 percent in the first half-year of FY24 to 48 percent in the second half-year. Headline inflation rates in Sonic’s markets are now in the range of 1.3 percent to 3.8 percent and gradually easing. The combination of these factors and $700 million additional annual revenue should deliver significantly higher earnings in FY26 and beyond.
Sixty-eight percent of revenue is sourced offshore
Expanding operations outside of Australia leaves Sonic increasingly exposed to exchange rate risk, being the risk that Sonic’s offshore earnings and assets fluctuate when reported in Australian dollars. Accordingly, in addition to statutory disclosures, elements of Sonic’s results are also reported on a “Constant Currency” basis. This enables comparability of the Group’s performance without distortion caused by exchange rate volatility.
To manage currency translation risk, Sonic relies on “natural” hedging under which foreign currency businesses and assets are matched with same currency debt. This means that as the Australian dollar value of offshore earnings and assets changes with currency movements, so does the Australian dollar value of the foreign currency interest expense and the foreign currency debt. This saves on foreign currency hedging costs, although Australian dollar reported earnings do fluctuate from year to year.
Ten percent FY25 earnings growth guidance
Inflationary pressures particularly on labour costs of the 42,000-workforce are showing signs of easing in FY25 and the Group has been right-sized now that the post-pandemic headcount reduction program is nearing completion. This has enabled Sonic to provide guidance in the range of A$1.7 to A$1.75 billion EBITDA for FY25, reflecting growth of up to 10 percent on FY24. July 2024 EBITDA is in line with budget. The earnings guidance assumes no changes in interest rates and includes completed acquisitions only.
Sonic’s global ‘roll-up’ of pathology services is a highly successful business model, given the synergies that arise on consolidation of laboratory infrastructure and distribution networks. Sonic is likely to continue expanding in this way for the foreseeable future and this growth trajectory should generate superior shareholder returns in the decade ahead.
