Is the covid-driven 'cash cow' for pathology stocks starting to unwind?
How much longer can pathology stocks go on milking covid?
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KEY POINTS
- PCR testing revenues are expected to top out in FY22 and fall -86% by FY24, according to Citi
- Have pathology companies' earnings and valuations become too dependent on covid testing?
- Why eCommerce stocks echo the same story that's taking place
The onslaught of covid testing has supercharged earnings for pathology companies like Sonic Healthcare (ASX: SHL), Healius (ASX: HLS) and Australian Clinical Labs (ASX: ACL).
According to the Australian, Royal Bank of Canada analyst Craig Wong-Pan expects long-run covid PCR testing revenues of about $164m and “based on current pathology market shares, this would imply $76m of revenue for Sonic Healthcare, $56m for Healius and $26m for ACL.”
In the near-term, Citi has forecast a far more lucrative market with $2.17bn revenue up for grabs in FY22, $900m in FY23 and $298m in FY24.
Supercharged earnings from PCR testing propped pathology stocks to all-time highs last year, with Sonic Healthcare and Healius rallying 45% and 42% respectively.
ACL, which listed on 14 May 2021, is up 57% to date.
‘Supercharged’ hits a soft spot
The term supercharged was often used to describe the growth tailwinds for eCommerce stocks during the height of the pandemic.
Names like Kogan (ASX: KGN), Redbubble (ASX: RBL) and Temple & Webster (ASX: TPW) experienced elevated growth as locked up consumers were forced to shop online.
As consumer shopping habits normalised, these stocks were quick to correct back towards pre-covid levels. In the past 12 months, these three stocks have tumbled between -38% and -70%.
While fundamentally very different businesses and sectors, the underlying narrative of short-lived tailwinds is very similar.
Pathology stocks might run the risk of deflating PCR testing revenues in the medium-to-long term. As Citi’s forecasts suggest, PCR volumes are forecast to decline around -86% between FY22 and FY24.
Would normalising PCR volumes also drive valuations back to pre-covid levels?
Core business in tact
Encouragingly, covid testing isn’t the be all and end all for pathology businesses.
In FY21, Sonic Healthcare, the largest ASX-listed pathology stock, reported a 6% increase in its base business compared to FY20.
When covid testing is included, revenues rose 28%.
In response to the results, Sonic said its “base business has become increasingly resilient to impacts of pandemic waves and benefits from geographical and business diversification.”
A rough start
Come 2022, pathology stocks are trading like the pandemic is coming to an end.
Sonic Healthcare, Healius and ACL are down between -9% and -13% year-to-date.
From a timing perspective, the selloff was broadly in-line with recent concerns about surging inflation and looming interest rate hikes.
This has weighed on more expensive and growth-oriented pockets of the market, notably technology stocks.
However, the recent run up of pathology stocks has kept valuations at bay, with the three pathology companies trading at price-to-earnings (P/E) ratios between 10 to 14.
According to Morningstar, the sector average for healthcare is 35.85.
