Why the Sonic (ASX:SHL) share price could be a hidden opportunity

The Sonic Healthcare Ltd (ASX:SHL) share price could be a hidden opportunity for investors with its high level of COVID-19 testing.

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The Sonic Healthcare Ltd (ASX: SHL) share price could be a hidden opportunity for investors to take advantage of.

Sonic shares haven’t done too much when you compare the current share price of $35.40 to the price of $30.78 on 6 March 2020.

But the business has actually been generating a lot of profit growth because of COVID-19 testing and this could be where an opportunity is waiting for investors.

How is the business going?

Sonic is a diversified pathology business with global operations across countries like the USA, Germany, Australia, the UK, Ireland, Switzerland, Belgium and New Zealand.

The company’s base/pre-COVID-19 business proved to be resilient in the first half of FY21, with revenue only down by 1% despite further waves of the COVID-19 pandemic.

It’s the COVID-19 testing that has really accelerated earnings for the business. Half-year revenue increased 33% to A$4.4 billion earnings before interest, tax, depreciation and amortisation (EBITDA) and net profit after tax (NPAT) went up 166% to $678 million.

The company’s COVID testing is playing an important part in controlling the pandemic. It has done over 18 million COVID-19 tests and it’s now seeing growing demand for immunity serology tests.

Why could the Sonic share price be an opportunity?

Firstly, the trading update that Sonic gave was particularly interesting. It said that it’s expecting a strong second half result based on the revenue growth trend in January and February.

It also revealed that “experience shows that temporary base business declines are more than offset by increased COVID-19 testing revenue”. If there are further waves, profit may increase faster, rather than being slowed down. 

The company continues to look for further growth opportunities, including acquisitions, contracts and joint ventures. It’s currently bidding on “significant” opportunities in Australia, the UK, the USA and Canada.

Sonic is showing signs of being increasingly resistant to impacts from COVID-19, partly thanks to the geographic and healthcare diversification of the business.

Earnings estimates seem to suggest that the market believes there will be a big decrease in Sonic’s earnings from FY21 to FY22, as COVID-19 testing drops off. For example, both Commsec and the broker Morgan Stanley seem to think that earnings per share (EPS) could decline by approximately $1 from this financial year compared to FY22.

But the decline may not be as much as investors are expecting. The number of new COVID-19 cases may be a lot lower in the US than a few months ago, and the vaccination rate is impressive, but that doesn’t necessarily mean that testing is going to drop off as much. Indeed, the US is starting to see COVID cases increase again in several major population areas as restrictions are lifted.

There is also the worrying prospect of variants spreading in Europe and North America that appear to be more contagious, able to reinfect people, be more resistant to vaccines and be more serious for younger people. This may mean that demand for Sonic’s testing capabilities goes on longer than expected.

There’s also the prospect that Sonic uses some of its elevated profit generation to acquire other global healthcare businesses to cement its market position.  

Sonic Healthcare share price valuation

According to Morgan Stanley, the Sonic Healthcare share price is valued at 13x FY21’s estimated earnings and 20x FY22’s estimated earnings.

After the 6% increase to the interim dividend, Sonic has a trailing partially franked dividend yield of 2.5%.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Sonic Healthcare Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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