Morgan Stanley’s top healthcare picks for ASX reporting season

Morgan Stanley says the recovery of healthcare earnings to pre-pandemic levels is more challenging than expected. Analysts favour companies that have recently provided guidance on upcoming earnings. 

“For most stocks, volume recovery to pre-pandemic levels has been sluggish accompanied by higher cost inflation, yet P/E multiples across the sector are generally inflated,” Morgan Stanley analysts said in a note on Tuesday.

“Staffing shortages have been a major detractor from volume recovery which could be more structural than transient (eg. nurses).”

Heading into August reporting season, the investment bank favours CSL (ASX: CSL) – which recently reset its FY24 expectations – as well as Sonic Healthcare (ASX: SHL) – where volume growth is robust and cost inflation has been contained.

Ratings and price targets at a glance

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Most preferred large caps: CSL, Ebos and Sonic Healthcare

CSL provided a market update on 14 June, which triggered a sharp 6.9% selloff. The update reaffirmed an FY23 net profit guidance of US$2.7 billion to US$2.8 billion and a first-time FY24 guidance of US$2.88 billion to US$3.01 billion, which missed analyst expectations. The stock has fallen a further 14% since the update and trading at levels not seen since July 2022. Morgan Stanley’s Overweight thesis is based on key points including:

• “Industry data suggest that the trajectory of plasma recovery is accelerating.”

• “CSL's plasma collections are now above pre-pandemic levels with positive momentum.”

• “We don’t see change to the long-term picture despite the downgrade to our forecasts following the market update, but rather a 6-12 month delay in getting there.”

CSL 12-month price chart (Source: Market Index)

EBOS Group is a New Zealand-based company that is the largest and most diversified Australasian wholesaler and distributor of healthcare, medical and pharmaceutical products. On 6 June, the company said its contract with Chemist Warehouse will not be renewed beyond its expiry date of 30 June 2024, which triggered a 12.3% selloff. 

Morgan Stanley says there may be risks to margins in FY25 when the Chemist Warehouse contract rolls off but otherwise bullish on its growth outlook.

• “We see EBO continuing to outgrow industry peers through market share gains, better cost leverage & balance sheet utilisation”

• “EBO to remain an earnings compounder: We estimate underlying NPAT CAGR of ~10% from FY22-27E via share gains, operating leverage in core markets, and platform acquired through LifeHealthcare”

• “Australian adoption of eScripts has been rapid and we see potential further upside for EBO still not currently incorporated into our Base Case estimates.”

EBOS 12-month price chart (Source: Market Index)

Sonic Healthcare shares bottomed in mid-February after an almost 40% correction from December 2021 highs. Morgan Stanley expects the recovery in its base pathology business to cushion the downfall of covid-testing revenues. Its Overweight thesis is based on base business growth as well as Sonic’s post-covid acquisition spree.

• “FY23 earnings should benefit from ongoing recovery in base business volume, favourable price mix and some contribution from COVID-19 PCR testing.”

• “SHL expresses intent to grow via acquisitions. A hypothetical A$3.5bn deal at 8x EV/EBITDA could lift SHL's EPS by ~high single digits, on our calculations.”

Sonic Healthcare 12-month price chart (Source: Market Index)

Underweight on service providers

The investment bank says staffing shortages have mostly inhibited service providers including Ramsay Healthcare (ASX: RHC), Healius (ASX: HLS) and Integral Diagnostics (ASX: IDX) – all three of which are Underweight rated.

For the heavyweight, the analysts flagged that the challenges of staff cost inflation and shortages, competition from homecare providers and lower private health insurance premium increases will see an earnings recovery softer than consensus expectations.

Ramsay Healthcare 12-month price chart (Source: Market Index)