Company Reports

We maintain our AUD 3 fair value estimate for no-moat Healius following CEO Maxine Jaquet’s decision to resign after serving as CEO for one year. The past year has proven challenging to navigate, with higher-margin coronavirus testing revenue largely disappearing while inflationary pressures mounted. This resulted in the company raising equity at a dilutive price in November 2023.

No-moat Healius’ first-half fiscal 2024 group revenue and EBIT fell 2% and 61% to AUD 849 million and AUD 16 million, respectively. This was largely due to higher-margin coronavirus revenue falling 97% but was broadly in line with our expectations. As flagged, first-half group EBIT excluding coronavirus testing was flat on last year, weighed down by rent and wage inflation.

In 2018, the former Primary Healthcare rebranded itself as Healius to signify the strategic turnaround underway. Healius is looking to new sources of strategic growth as well as dealing with prior underinvestment in infrastructure. There is much to fix in the business and we anticipate it to take a few years before significant margin improvements are made in the base pathology and imaging businesses. Healius selling its medical centers and Montserrat day hospitals to focus on redirecting capital toward infrastructure upgrades and its diagnostic businesses is viewed as a positive strategic step.

No-moat Healius downgraded fiscal 2024 EBIT guidance by 25% at the midpoint of AUD 70 million-AUD 80 million. This was due to industry growth moderating significantly late in 2023 because of softness in general practitioner attendances and resulting pathology referrals. GP shortages and cost-of-living pressures are hurting pathology growth, and given its own inflationary cost pressures, Healius must resize its labor and infrastructure costs. We reduce our EBIT forecasts by 15% on average over the next two years on 2% lower forecast revenue and margins contracting more than we previously expected. However, our long-term estimates are broadly unchanged, including our midcycle EBIT margin forecast of 14%.

In 2018, the former Primary Healthcare rebranded itself as Healius to signify the strategic turnaround underway. Healius is looking to new sources of strategic growth as well as dealing with prior underinvestment in infrastructure. There is much to fix in the business and we anticipate it to take a few years before significant margin improvements are made in the base pathology and imaging businesses. Healius selling its medical centers and Montserrat day hospitals to focus on redirecting capital toward infrastructure upgrades and its diagnostic businesses is viewed as a positive strategic step.

Australian Clinical Labs intends to withdraw its takeover offer for Healius after opposition from the Australian Competition and Consumer Commission. The ACCC concluded the acquisition would likely substantially lessen competition in Australian pathology services markets. The ACCC considered current competitors, including narrow-moat Sonic Healthcare, and believes it is unlikely that a new or existing provider could enter or expand in a timely way and to a scale sufficient to address the potential loss of competition.

In 2018, the former Primary Healthcare rebranded itself as Healius to signify the strategic turnaround underway. Healius is looking to new sources of strategic growth as well as dealing with prior underinvestment in infrastructure. There is much to fix in the business and we anticipate it to take a few years before significant margin improvements are made in the base pathology and imaging businesses. Healius selling its medical centers and Montserrat day hospitals to focus on redirecting capital toward infrastructure upgrades and its diagnostic businesses is viewed as a positive strategic step.

Healius benefited substantially in first-half fiscal 2021 from its involvement in coronavirus testing in Australia. While Australian community transmission of the coronavirus has fallen to very low levels in early 2021, the pandemic remains highly dynamic. Therefore, the ultimate earnings benefit that Healius will derive from it remains difficult to forecast. Nonetheless, with demand for coronavirus tests proving far more buoyant in fiscal 2021 year to date than we’d previously anticipated, we increase our full-year fiscal 2021 EBIT forecast by a sizable 33% to AUD 223 million. Also contributing to our upwardly revised estimates is a marked improvement in the performance of the day hospitals segment—with Healius day hospitals and Adora Fertility achieving maiden profits during the first half, ahead of our prior expectations. Accounting for the anticipated spike in fiscal 2021 pathology earnings and the improved medium-term outlook for day hospitals, we lift our fair value estimate by 4% to AUD 3.85 per share. Shares in the no-moat stock screen as fairly valued.

In 2018 the former Primary Healthcare rebranded itself as Healius in an effort to signify the turnaround underway. The new CEO, appointed in 2017, is looking to new sources of strategic growth as well as dealing with prior underinvestment in systems, revamp of physical spaces and legacy issues with stakeholder management. There is much to fix in the business and we anticipate it to take two years to see the major benefits from the turnaround delivered in the financial results. The COVID-19 impact of lost pathology and diagnostic imaging volumes in fiscal 2020, and expected to spill over into fiscal 2021, has stalled the turnaround, as it has exposed the combination of high operating and financial leverage. However, the business focus created by selling the medical centres in fiscal 2021, which were weighing down the turnaround, is viewed as a positive strategic step.

Healius’ efforts to strip cost from its Australian pathology and imaging businesses are bearing fruit in early fiscal 2021. Year-to-date cost reductions under its cost-out program--referred to as its Sustainable Improvement Program, or SIP--have tracked ahead of management’s previously announced medium-term target and our expectations. With Healius more confident its SIP can sustainably improve operating margins for its pathology and imaging businesses, we increase our fair value estimate for the no-moat name by 9% to AUD 3.70 per share. An increase in corporate overheads and near-term capital expenditures--required to realise cost-out targets under the SIP--provide a partial offset to our valuation uplift. Healius shares screen as modestly overvalued, trading at a 6% premium to our revised fair value estimate.

In 2018 the former Primary Healthcare rebranded itself as Healius in an effort to signify the turnaround underway. The new CEO, appointed in 2017, is looking to new sources of strategic growth as well as dealing with prior underinvestment in systems, revamp of physical spaces and legacy issues with stakeholder management. There is much to fix in the business and we anticipate it to take two years to see the major benefits from the turnaround delivered in the financial results.

We’d anticipated that Healius’ ongoing involvement in coronavirus testing would deliver a transitory boost to the no-moat name’s fiscal 2021 earnings. However, year-to-date demand for COVID-19 tests has tracked significantly ahead of our full-year expectations, driving a remarkable 17% sales growth rate in first-quarter fiscal 2021. The ultimate duration and severity of the global pandemic are unknowns, begetting substantial near-term uncertainty as to the precise magnitude and persistence of demand for COVID-19 tests. Nonetheless, we expect elevated levels of COVID-19 testing will remain throughout the remainder of fiscal 2021. Accordingly, we upgrade our fiscal 2021 group sales and EBIT estimates to AUD 1.77 billion and AUD 172 million, respectively. Our revised fiscal 2021 group sales and EBIT forecasts are 5% and 23% greater than our respective prior estimates. The outsize upgrade to fiscal 2021 operating income is the result of the substantial operating leverage that prevails within Healius’ pathology business. While our long-term expectations for Healius remain unchanged, the substantial near-term earnings upgrade drives a 3% increase in our fair value estimate to AUD 3.40 per share. Healius shares screen as overvalued, trading at a circa 10% premium to our revised fair value estimate.

In 2018 the former Primary Healthcare rebranded itself as Healius in an effort to signify the turnaround underway. The new CEO, appointed in 2017, is looking to new sources of strategic growth as well as dealing with prior underinvestment in systems, revamp of physical spaces and legacy issues with stakeholder management. There is much to fix in the business and we anticipate it to take two years to see the major benefits from the turnaround delivered in the financial results. The COVID-19 impact of lost pathology and diagnostic imaging volumes in fiscal 2020, and expected to spill over into fiscal 2021, has stalled the turnaround, as it has exposed the combination of high operating and financial leverage. However, the business focus created by selling the medical centres in fiscal 2021, which were weighing down the turnaround, is viewed as a positive strategic step.

The decline in activity levels across most Australian medical facilities due to deferral of non-urgent care has exceeded our initial expectations. We are now expecting volumes in the last quarter of no-moat Healius’ fiscal 2020 to decline 20% in pathology and 40% in the diagnostic imaging segment. We expect GP services to be less affected as a result of expansion of the government funded telehealth services. Pathology contributes approximately 60% of Healius’ revenue, and imaging and medical centres 20% each. We reduce our fiscal 2020 group revenue forecast to AUD 1.84 billion from AUD 1.94 billion prior, and our net profit forecast to AUD 48 million from AUD 99 million given the company’s high fixed cost base. We expect the volume decline to moderate in the first quarter of fiscal 2021 and growth to return thereafter as elective and routine work returns. But the near-term profit declines, combined with an anticipated equity issuance to shore up the balance sheet, lead us to reduce our fair value estimate to AUD 2.90 from AUD 3.36, and increase our uncertainty rating to very high from high.

We are disappointed the board of no-moat Healius rejected the nonbinding acquisition proposal at AUD 3.40 per share as the cash offer was comparable with our fundamental fair value estimate for the company. Rejection of the offer comes after the company abandoned targets for the turnaround and seeks a buyer of the medical centres division. Despite evidence of improvement in the margins of the pathology and diagnostic imaging segments in the most recent results, we believe the AUD 3.40 proposal effectively crystallises the benefits of the turnaround and accepting it would have been in shareholders’ best interests.

The decline in no-moat Healius’ medical centres business in the first half was unexpected. While we had not fully factored in management’s prior GP recruitment and profitability targets, the weak results and management conceding the medical turnaround is proving more challenging than anticipated has caused us to revise our outlook. Consequently, we decrease our fair value estimate for Healius to AUD 3.36 from AUD 3.50 per share. Our valuation includes a 25% probability the private equity offer at AUD 3.40 per share is successful, although this has little impact given it’s close to our standalone AUD 3.34 valuation. Since the board declined to present a take-out offer, at a slightly lower AUD 3.25 per share, in January 2019 and referenced a potential sale of the medical centres business-- an estimated 10% of earnings--we place a relatively low likelihood on the deal going through.

No-moat Healius is currently in the investment phase of its turnaround and the positive fiscal 2020 trading update provided at today’s AGM, provides confirmation. The firm quantified expected underlying net profit after tax, or NPAT, of between AUD 94 million and AUD 102 million, equating to between 1% and 9% growth on the previous corresponding period, or pcp. Our unchanged estimate of AUD 96.5 million underlying NPAT is within this range. This excludes the spend on strategic projects to fuel the turnaround, which we forecast at AUD 40 million for fiscal 2020. We expect flat reported NPAT year on year. Shares screen as slightly undervalued at current levels versus our AUD 3.50 per share fair value estimate.

No-moat Healius’ fiscal 2019 result was in line with our expectation and showed signs that the major restructuring and reinvestment underway is gaining traction. Importantly, the company was able to attract over a hundred additional GPs to operate from its medical centres, a key driver of revenue in this segment. Following a transfer in analyst coverage, our unchanged AUD 3.50 fair value estimate factors in a substantial improvement in the medical centre revenue growth at 9.3% over the next five years, but assumes it will take longer than management have targeted to grow the GP base. While currently contributing just 18% of revenue, the medical centre revamp received 60% of the capital raised in fiscal 2019 and is an important part of Healius’ turnaround.

After rallying approximately 35% since the beginning of calendar 2019, shares in Healius are now modestly undervalued relative to our unchanged AUD 3.50 fair value estimate. Major shareholder Jangho's takeover bid in early January 2019 was opportunistic, and the subsequent rejection by the board reflected our opinion that the AUD 3.25 bid undervalued the firm. Healius' large-scale medical centres generate dependable earnings, and its pathology division in particular enjoys competitive advantages--although not enough to warrant an economic moat rating.

No-moat Healius reported underlying net profit after taxes of AUD 39 million for the first half of fiscal 2019, down 10% from the prior corresponding period. The weak performance reflected soft market conditions across all divisions, mostly driven by the benign winter flu season. However, we do not expect these conditions to continue and expect volumes to eventually revert toward the historical norm. The second half of fiscal 2019 should improve, as efficiency initiatives in pathology and imaging contribute an approximate AUD 10 million EBIT uplift. The board declared an interim fully franked dividend of AUD 3.8 cents per share, which represents an approximate 60% payout ratio that we believe can be sustained through the cycle.