Sonic benefits from cost efficiencies by maximizing throughput through its network of laboratories and collection centers

Business Strategy & Outlook

Sonic’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders. Sonic’s organic volume growth in its core laboratories segment has typically ranged between 3% and 4%. The volume growth is underpinned by population growth, aging demographics in developed markets, higher incidence of diseases, and wider adoption of preventative diagnostics to manage healthcare costs. In addition, the number of tests available is expanding. Increasing complexity of tests, such as veterinary and gene-based testing, is also resulting in average fee price increases.

Laboratory medicine, or pathology, has a high fixed cost of operation and thus benefits from volume growth to drive lower cost-per-test outcomes. Sonic benefits from cost efficiencies by maximizing throughput through its network of laboratories and collection centers. Higher testing volumes result in a lower cost per test as labor, equipment, leases, transportation, and overhead costs are all leveraged. The company has historically been highly acquisitive, particularly overseas. Synergies from procurement and integrating IT are relatively easy to capture, and given its cost advantage, Sonic is well placed to boost its organic revenue with bolt-on acquisitions. The U.S. and Germany are singled out as the most likely sources of acquisitions given their fragmented markets. In addition to acquisitions, Sonic is sourcing more volumes to put through its laboratories from joint ventures with hospitals in the U.S., whose in-house laboratories are typically subscale and would operate at higher costs. Operating capacity within Sonic’s existing laboratories is highly flexible by adjusting operating hours.

Financial Strengths

Sonic is in a strong financial position. Free cash flow conversion of earnings prior to acquisition spend has averaged 99% over the last 10 years and has allowed Sonic to quickly repay the debt funding its acquisitions. In June 2022, Sonic reported AUD 797 million in net debt representing net debt/EBITDA of only 0.3 times, below the 2.0 to 2.7 times range targeted by management, and well below the 3.5 times covenant. A similarly strong cash conversion can be seen, and in the absence of major acquisitions, the company will be in a net cash position for most of the 10-year forecast period. The high cash conversion affords Sonic a generous dividend payout ratio, which is to be consistent with the historical average of approximately 75% of earnings. Sonic also has a progressive dividend policy which is communicated as a minimum of an equal dividend per share to the prior year.

Bulls Say

Sonic has a leading market position in most of its geographies and as a result benefits from a cost advantage derived from scale.
On top of the base level of COVID-19 testing that is likely to continue, demographic factors, and the focus on value-based healthcare support global volume growth in preventative diagnostics.
Advances in technology and personalized medicine are increasing the number of complex and gene-based tests available to patients which are typically higher-margin.

Company Description

Sonic Healthcare is a global pathology provider. It is the largest private operator in Australia, Germany, Switzerland and the U.K., the second largest in Belgium and New Zealand and the third largest in the U.S. In addition to pathology, which contributes roughly 85% of group revenue, Sonic is the second largest player in diagnostic imaging in Australia and the largest operator of medical centers in Australia. The company typically earns about 40% of group revenue in Australia and New Zealand, 25% in the U.S. and 35% in Europe.

(Source: Morningstar)

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