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Sonic Healthcare: The last decade

For a company with a market value of nearly $6 billion, Sonic Healthcare (ASX: SHL) certainly seems to fly under the radar. Having been listed on the ASX since 1987, the medical diagnostics company has grown from just one pathology practice in Sydney to a multi-national corporation offering laboratory medicine, pathology and radiology services in eight countries on three continents and employing 26,000 people across Australia, NZ, the UK, Europe and the USA. What’s more, the company is a top three player in each of its markets.

The company has been guided under the steady hand of Dr Colin Goldschmidt, who has been Managing Director (MD) of Sonic since 1993 and deserves credit for creating shareholder wealth. With the company’s full-year results due to be announced on 20 August, now seems like a good opportunity to review the past performance of Sonic.

2003

Ten years ago, management talked about earnings before interest, tax and non-economic amortisation (EBITA) which is a useful and meaningful measure. Pleasingly today they still present this number although the ‘promotional’ EBITDA is also present. In 2003, EBITA was $173 million on revenues of $975 million. Adjusted earnings per share (EPS) were 37.8 cps and the company paid a dividend of 25 cents per share (cps).

Now

Financial year 2012 saw Sonic produce a record profit of $316 million on revenues of $3.3 billion. EBITA grew to $514 million, resulting in EPS of 80.7 cps and a dividend of 59 cps. Meanwhile the interim 2013 result was $256 million and with earnings skewed to the second half, and management is expecting a high single-digit growth rate for the full year, setting 2013 up for another record profit.

One concerning issue that has appeared over the past decade is the low rate of return on invested capital. The 2012 Annual Report states that Sonic produced a return on invested capital of 9.8% — this is a poor return and likely below its cost of capital. As Goldschmidt goes on to explain in his report, “in the six years to 2011, the Company invested heavily to establish significant market presences in carefully selected, fragmented northern hemisphere markets. In the early phases of this expansion, earnings per share growth was achieved but as expected, there was a temporary dilution in returns.” The MD appears to have a clear grasp of the need to boost returns above Sonic’s cost of capital; however investors should watch closely to see that this is achieved.

The closest competitor to Sonic is Primary Health Care (ASX: PRY), which is also a significant player in the domestic pathology and diagnostic imaging market. Investors have certainly been better off if they chose to invest in Sonic rather than Primary over the past decade with Primary’s shares up just 19% compared with Sonic’s 112% rise. In contrast, the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is up 59%.

Foolish takeaway

Ten years ago Sonic was trading on a price-to-earnings multiple of 19 times, which was justified given the enormous growth it has achieved over the past decade. Today the company trades on around 18 times, which is understandable given its past performance and potential for future growth. Perhaps the most instructive aspect of a review of the past decade is that, over time growth in share price roughly mirrors earnings per share growth.

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Motley Fool contributor Tim McArthur owns a share in Primary Health Care.

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