Is the covid-driven 'cash cow' for pathology stocks starting to unwind?

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.