Morningstar | Strategic Expansion in Anatomical Pathology Positive, Maintain FVE of AUD 25.50. See Updated Analyst Note from 08 May 2019
We transition coverage in narrow-moat Sonic Healthcare and maintain our fair value estimate of AUD 25.50. We continue to view Sonic’s strategic expansion into the high growth anatomical pathology market as positive, and the recently completed Aurora acquisition gives the company a good foothold in the very large U.S. market. Fiscal 2019 EBITDA guidance was upgraded to 6% to 8% constant currency growth from 3% to 5% to factor in the acquisition, in line with our forecast 6.4% gain. At the current price, shares screen as fairly valued.We forecast fiscal year 2019 core EPS growth of 7.9% to AUD 1.16 from AUD 1.08, of which 4.3% is constant currency growth and the balance a short term boost from a relatively weaker AUD reporting currency. While the currency provides a tailwind, an 11% increase in the number of shares in issue dilutes per share metrics in the 2019 and 2020 fiscal years. Our core EPS excludes the once-off AUD 20 million gain in the prior year, an effect of the change in the U.S. corporate tax rate.
We project a five-year CAGR in revenue and core EPS of 8% which includes the Aurora acquisition and share issuance, but no other major acquisitions. Operating margin expands to 12.9% from 12.5% as scale benefits are partially offset by some of the newer margin-dilutive initiatives. The most disappointing aspect of the 2019 interim result was margin contraction in the key laboratory segment, following previous guidance for margin expansion over the longer term which we continue to factor into our forecasts.
We expect strong cash flow generation to continue, with an average of 98% cash conversion of earnings matching results over the past five years. Sonic has a progressive dividend policy and is currently paying out approximately 75% of earnings which we forecast to lower to a 70% payout ratio over time, resulting in DPS growth of 5%, slightly lagging our projected EPS growth.
Sonic Healthcare is involved in the provision of medical diagnostic services and the provision of administrative services and facilities to medical practitioners. Co. provides specialized pathology/clinical laboratory and diagnostic imaging services to clinicians, hospitals, community health services, and their patients. Co.'s segments are comprised of: Laboratory, which provides Pathology/clinical laboratory services in Australia, New Zealand, the U.K., the U.S., Germany, Switzerland, Belgium and Ireland; Imaging, which provides diagnostic imaging services in Australia; and Other, which Includes medical center operations and occupational health services.
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