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Why you should add Sonic Healthcare Limited to your portfolio today

Some healthy gains may be in order for Sonic Healthcare Limited  (ASX: SHL) as a result of the US healthcare reforms (Obamacare) that came into effect on January 1, 2014.

Sonic is an international medical diagnostics company offering laboratory medicine, pathology and radiology services to the medical community. Its main competitor in Australia is Primary Health Care (ASX: PRY), which derives 100% of its earnings from Australia and thus lacks the geographical diversification of Sonic.

Of Sonics’ total revenue, 79% is from pathology, a fact not lost on Chief Executive Colin Goldschmidt, who expects new growth in pathology services because approximately 15% of the US population (49 million people) will be newly eligible for health insurance coverage. Obamacare increases access to medical care for those not working and thereby not covered by employee plans.

Many experts suggest that of the Australian healthcare companies with US exposure, Sonic gains the most benefit over the medium- to long term, compared to CSL (ASX: CSL), Cochlear (ASX: COH) and Resmed (ASX: RMD). This is because the less discretionary products of the latter trio are not impacted greatly from the increased insurance coverage. For example, the cover provided to a newly insured would be insufficient for a Cochlear implant.

Why invest now?

In addition to the Obamacare boost, the most recent reporting season in August revealed upgrades from brokers due to a US$60 million cost-cutting program in the U.S, above consensus pathology margins and strong medical centre margins. On top of potential capital growth, it is yielding a nearly 4% partially franked dividend.

As the company derives 49% of its revenue from overseas, of which North America comprises 21%, it is highly sensitive to a widely predicted fall in the Aussie dollar.

Finally, in mid-December 2013 the company suffered a share price fall as a result of investors inappropriately extrapolating recently released earnings expectations of two of its US competitors. Sonic was then forced to deny any impact and in the process updated the market by reaffirming its earnings guidance for FY 2014 and revealed substantial earnings growth in its US business for the five months to 30 November. Furthermore, it expects to continue to do so for the full 2014 and 2015 financial years.

Foolish takeaway

One potential negative is that Sonic operates in an industry subject to policy and government change and further reforms to Australian, US or German equivalents of Medicare may weigh on the stock. However, in my opinion, a number of tailwinds will propel Sonic higher over time and it is an ideal core holding for medium-to-long term investors.

 

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