Analysis of Sonic Healthcare: Share Price, DCF Valuation, Dividend Policy and Capital Structure

This report provides an analysis of Sonic Healthcare including share price, DCF valuation, dividend policy and capital structure. The report includes a table of contents, figures and references.

MANAGERIAL FINANCE
Managerial Finance
Analysis of Sonic Healthcare

2MANAGERIAL FINANCE
Table of Contents
Task 1. Analysis of share price of Sonic Healthcare.................................................................3
Task 2. Discounted Cash Flow Valuation of Sonic Healthcare.................................................4
Task 3. Dividend Policy of Sonic Healthcare............................................................................6
Task 4. Capital Structure of Sonic Healthcare...........................................................................7
References..................................................................................................................................8

3MANAGERIAL FINANCE
Task 1. Analysis of share price of Sonic Healthcare
The share price of Sony Healthcare remained highly volatile in 2018 amid market turbulence
(Sonic Healthcare, 2019). While the defensive nature of the stock with a low beta along with
a stable history of dividends keeps the stock attractive for most buyers, some investors think
that there are more attractive picks among the smaller peers delivering better returns. The
spike towards the end of the year has been majorly due to the Aurora acquisition deal
announcement by the company (LaFrenz, 2018). The company is expected to be the third
largest player in the US market post this deal finalisation. The proportion of revenue coming
from the US is expected to rise to 26% from the current 20% (Market Matters, 2018). Sonic
Healthcare considers this deal to reduce its dependence on Australian market amidst the
current volatility observed in the nation’s healthcare sector. The recent increase in share price
backed by higher trading volume strengthens the growing interest of the market towards the
company’s share.
Figure 1.
Source: Adapted from Sonic Healthcare, (2019)

4MANAGERIAL FINANCE
Task 2. Discounted Cash Flow Valuation of Sonic Healthcare
The recommendation for security is buy based on estimated intrinsic value per share of
AUD$26.51 against current share price of AUD$22.78. The company is expected to continue
its growth trajectory based on strong revenue backed by consistent demand from an ageing
population in all the eight nations that the company is operating in including Australia and
the USA (Bell Potter Securities Research, 2018). With the confirmation of the Aurora deal,
revenue growth will remain intact as the company increases its foothold in the USA and
reduces its dependence on home country. Long term growth for free cash flow has been
derived from the projected growth rate of advanced countries sourced from IMF
(International Monetary Fund, 2018). The company is highly defensive as evident from its
Beta of 0.58. Further, it is a good buy for the investor valuing a steady stream of dividends
(Wall Street Journal, 2019). The company is currently trading at a TTM P/E ratio of 21.48,
far lower than the industry average of 38.02 (Reuters, 2019). Hence, it is an attractive buy at
current price.

5MANAGERIAL FINANCE
DCF Valuation of Sonic Healthcare
Figure 2. Source: Adapted from Sonic Healthcare (2019), Reuters (2019), International
Monetary Fund (2018) and Wall Street Journal (2019)
Kc 4.52% 30-06-2019 30-06-2020 30-06-2021
PV factor 0.9809 0.9384 0.8978
AUD Million 2016 2017 2018 2019E 2020E 2021E
Revenue 4967 5054 5420 5664 5918 6185
% growth 1.8% 7.2% 4.5% 4.5% 4.5%
COGS 3336 3410 3718 3853 4027 4208
% of Sales 67.5% 68.6% 68.0% 68.0% 68.0%
SG&A 651 1066 1114 1179 1232 1288
% of Sales 21.1% 20.6% 20.8% 20.8% 20.8%
EBIT 980 578 588 631 659 689
-41.0% 1.7% 7.3% 4.5% 4.5%
EBIT/Revenue 11.44% 10.85% 11.14% 11.14% 11.14%
Pretax Income 598 576 617
Income tax 132 133 132
Tax rate 22.1% 23.1% 21.4%
Effective Tax rate 21.39%
NOPLAT 764 445 462 496 518 542
Capex 394 409 328 342 358 374
% of Sales 7.9% 8.1% 6.0% 6.0% 6.0% 6.0%
Dep & Amort. 220 228 256 262 273 286
% of Sales 4.4% 4.5% 4.7% 4.6% 4.6% 4.6%
Working Capex 56 51 30 31 33 34
% of Sales 1.1% 1.0% 0.6% 0.6% 0.6% 0.6%
FCF 534 212 361 384 401 419
Terminal Value 14086
PV of Cash flows 376 376 13023
Long-term Growth rate 1.5% Growth rate of advanced nations - IMF
Kd 2.8%
Value of Debt 2792
Interest expense 78
Ke 5.8%
Beta 0.58
Market premium 6.04%
Risk free rate 2.30%
Market Cap 9835
Shares Outstanding 426
WACC 4.52%
Enterprise Value 13776
Debt 2792
Cash 313
Equity Value 11297
Value per share 26.51
Current Price per share 22.78

6MANAGERIAL FINANCE
Task 3. Dividend Policy of Sonic Healthcare
Dividend Policy and Capital Structure
(AUD $ million except per
share values) 2016 2017 2018
Dividend 215 276 234
Net income 451 428 476
Dividend Payout ratio 47.6% 64.4% 49.1%
Growth rate in dividends 28.4% -15.3%
Shares Outstanding 426
DPS 0.55
Price per share 22.78
Dividend Yield 2.41%
LT Debt Equity Ratio (MRQ) 66.8%
Interest Coverage (TTM) 9.75
Figure 3. Source: Adapted from Wall Street Journal (2019) and Reuters (2019)
The company follows an aggressive dividend policy with 5-year average dividend yield of
3.39 as against industry average of 0.86 (Reuters, 2019). While some investors like to buy a
stock offering a regular stream of income in the form of dividends, sometimes market
considers such a progressive dividend policy to be the result of a lack of investment
opportunities in the hands of the management thereby distributing the major chunk of net
earnings instead of retaining for financing prospective high growth projects. This has a
depressing effect on the share price with investors moving away in search of companies with
more promising growth prospects.
Again, following a progressive dividend policy leaves less funds with the company in the
form of retained earnings. In case of a major project coming up for investment, the company
following an aggressive dividend policy would not be able to finance through the cheaper
source of retained earnings and may have to resort to raising additional equity which is more
expensive.

7MANAGERIAL FINANCE
Task 4. Capital Structure of Sonic Healthcare
The overall cost of capital or weighted average cost of capital has been calculated in Task 2.
The current capital structure is quite aggressive with high long-term debt to equity ratio of
66.84% compared to 43.76% for the industry (Reuters, 2019). Although interest coverage
remains at comfortable zone, it is much lower than the industry average of 26.21 times
(Reuters, 2019). Hence, it would be difficult for the company to raise additional debt at
competitive rates from the market. Conversely, high financial leverage vis-à-vis competitors
means that company provides attractive return on equity to its shareholders through
maximum usage of the cheaper debt fund in its capital structure. The TTM return on equity of
11.38% is considerably higher than industry average of 0.47% (Reuters, 2019). Additionally,
the company currently remains at a comfort zone with regard to the interest coverage ratio
depicting that its capital structure is acceptable.

8MANAGERIAL FINANCE
References
Bell Potter Securities Research. (2018, Decemeber 13th). Sonic Healthcare Limited.
Retrieved from Morningstar:
http://www2.aspecthuntley.com.au/pdf/bellpotter/companyprofile/today/SHL_cp.pdf
International Monetary Fund. (2018). World Economic Outlook. Washington: International
Monetary Fund.
LaFrenz, C. (2018, Dec 12th). Sonic Healthcare beefs up US operations in $750m deal.
Retrieved from Financial Review: https://www.afr.com/business/health/sonic-
healthcare-beefs-up-us-operations-in-750m-deal-20181212-h190ll
Market Matters. (2018, December 12th). What you need to know about Sonic Healthcare
Limited (ASX: SHL) acquisition and cap raise. Retrieved from Market Matters:
https://www.marketmatters.com.au/news/2018/12/12/asxshl/
Reuters. (2019, January 22nd). Sonic Healthcare Ltd (SHL.AX). Retrieved from Reuters:
https://www.reuters.com/finance/stocks/financial-highlights/SHL.AX
Sonic Healthcare. (2019, January 22nd). Historical Share Price. Retrieved from Sonic
Healthcare: https://investors.sonichealthcare.com/investors/?page=historical-share-
price
Wall Street Journal. (2019, January 22nd). Sonic Healthcare Ltd. Retrieved from The Wall
Street Journal: https://quotes.wsj.com/AU/XASX/SHL/research-ratings