Sonic Healthcare drops -4% following another downgrade

Following on the heels of Ord Minnett’s late-August downgrade to Hold from Accumulate (price target to $36.00 from $37.50) – due to a projected decline in testing volumes across all major markets, Goldman Sachs has downgraded Sonic Healthcare (ASX: SHL) to Sell from Neutral in fear of asymmetric downside risk from here.

In light of a tougher cost environment and a health system with funding and staffing challenges, these two brokers suspect declining testing volumes flags the end of a period of super profits for the large-cap healthcare provider.

What’s driving the downside risk?

Despite performing at least as well as peers through the pandemic, Goldman’s believes the profitability gains experienced through covid will be hard to maintain.

The broker is concerned that recent profitability gains could be impacted by an uncertain business recovery.

While the implications that covid volumes are near-trough may be optimistic , Goldman’s suspects it may mask continued pressure from the steady shift towards panel-based testing.

The broker also looks to the share price, which has failed to perform (-2% vs. sector 9%) despite completing $300m of its $500m buyback since the first half update.

Goldman’s notes while synergistic M&A activity is possible, management appears hesitant in the face of heightened market uncertainty.

Source: Goldman Sachs

Risk-reward

Goldman’s notes while Sonic shares has outperformed the sector 42% since April-2020, the broker FY24 earnings are -15% below pre-covid forecasts.

“SHL [Sonic] faces a declining growth/margin profile through to FY25E which will increasingly screen negatively,” Goldman’s notes.

“We cut FY23/24E NPAT by 3/11% and now forecast negative FY22-25E sales/NPAT CAGRs of (2)%/(20)%.”

The broker’s revised 12-month target price of $31.70 implies -11% downside versus 9% median across its coverage.

What other brokers think

Sonic Healthcare is down -20% over one year and was -4% down at the close following Goldman’s downgrade this morning.

Consensus on Sonic is Hold.

Based on Morningstar’s fair value of $38.55 the stock appears to be undervalued.

Based on the six brokers that cover Sonic (as reported on by FN Arena) the stock is currently trading with 5.6% upside to the target price of $36.15.

Morgan Stanley, which has the highest target price of $38.60, maintains an Overweight rating and is encouraged that (key risk) cost inflation pressures weren't evident [during FY22), while the base business accelerated more than expected.

The broker is also encouraged that despite recent Medicare data, suggesting a softening of diagnostic imaging growth, the group still managed 2% organic growth while second half earnings margin showed resilience.

Morgan Stanley is forecasting a full year FY23 dividend of 104.20 cents and EPS of 187.00 cents.

Sonic Healthcare share price over three months.