For those companies with the money to spend on acquisitions the global financial crisis has opened up a range of opportunities, as potential purchases are now valued at far less than was the case prior to the downturn. As an example, Southern Cross Equities points to Sonic Healthcare (SHL), as it estimates potential acquisitions that were trading on 8-9 times EBITDA (earnings before interest, tax, depreciation and amortisation) are now available for around 5-6 times.
This leads the broker to suggest while the company is facing a slower earnings growth outlook in both FY10 and FY11, thanks to currency headwinds from a stronger Australian dollar, it can put its acquisition warchest of around $775 million to work to expand its operations in the key markets of the US and Europe. Germany is the most likely candidate for further acquisitions in Europe in its view, given the company has already enjoyed some success in that market.
What also makes Germany a likely target market is the fact there has been some recent consolidation among pathology players, with even private equity getting into the act as evidenced by BC Partners buying 40% of Synlab and 100% of Futurelab. In the broker’s view, the German market is attractive as the labs are efficient and reimbursement rates are squeezing the smaller players, so potentially making them more willing sellers.
Demographics are also favourable for the German lab companies given a median age of around 44 years, wich suggests an accelerating demand for health care services. Given this the broker sees scope for Sonic to achieve a number one position in that market, especially if it looks to expand into the eastern and southwestern regions of the country where it has yet to build much of a presence.
Assuming the company were to spend $800 million on acquisitions over the next two years and it paid an EBITDA multiple of six times in the deals for companies earnings EBITDA margins of 15%, the broker estimates group EPS could increase by around 5% in 2010 and 14% in FY11, which would more than offset the currency pressures the company is facing.
With no acquisitions specified as of yet and given the stronger Australian dollar, the broker has trimmed its earnings forecasts in coming years, cutting its FY10 number by 3% and its 2011 estimate by 6%. In earnings per share (EPS) terms this leaves it forecasting outcomes of 89.6c in FY10 and 96.9c in FY11, while consensus EPS forecasts according to the FNArena database stand at 90.9c and 101.6c respectively. (This suggests Southern Cross is ahead of the pack in lowering its forecasts).
Having made some changes to its model such as lowering the discount rate and cutting long-term revenue growth estimates slightly, the broker has come up with a base case valuation on the stock of $14.42, rising to $16.23 under more optimistic assumptions. It has set its price target in the middle of this range at $15.50, which equates to an earnings multiple of around 16 times FY11 earnings.
This compares to an average price target according to the database of $15.30. RBS Australia is the low marker in terms of targets at $13.85, while Macquarie is the most bullish given a target of $16.83. Along with the Buy rating of Southern Cross Equities, the database shows the stock is rated as Buy five times, Accumulate once and Hold four times, with no changes to ratings or targets today despite some minor increases to earnings estimates after the company announced yesterday it was being invited back into the Auckland pathology market previously dominated by Healthscope ((HSP)).
Shares in Sonic Healthcare today are higher and as at 2.40pm the stock was up 13c at $13.61, which compares to a trading range over the past year of $9.96 to $14.85.