Important - bwts.com.au · Mkt Av Assessment Plan Req V Plan Price Earnings Ratio 18.81 16.22 OK Dividend Yield 3.91% 4.04% OK Franking 45% Yes Low If not fully franked, the dividend

Copyright © Colin Nicholson Page 1

Stock Journal

Sonic Healthcare

Important

I am publishing stock investment journals of stocks I own only to provide examples to teach the way I think about investing. In doing so, I am neither making nor implying any recommendation for anyone to invest in this or any other stock.

Therefore, the stock discussed in this journal may not be a suitable investment for you at this or any other time. I will only be discussing its suitability, or otherwise, for my investment plan.

You need to assess the relevance of anything in this journal to your investment plan, seeking advice from a licensed adviser if you are not able to make such an assessment for yourself.

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Terms and acronyms used in this journal

See the Glossary page on the Free Resources menu for definitions. There are also articles on some of the ratios on the Fundamental Analysis Articles page on the Copyright Materials page.

If I use a term or acronym that is not in the Glossary, please email me for an explanation and I will add it to the Glossary page.

The ratios used in my analysis are set out in the document Ratios Used in my Analysis on the Stock Investment Journals page on the Building Wealth Resources menu. It includes a basic definition of annualised data.


How I found this stock Sonic Healthcare has been forming a multi-year sideways pattern. It had come up several times on my scan for new 52-week highs and has been on my watch list for a while. However, until my recent reassessment of my strategy in the current market, it did not quite meet all of my investment plan criteria.

My recent interim change in strategy has brought it into consideration for purchase.

Company profile


Which model?

I am seeing this as a growth model chart. The only reservation is the width of the sideways pattern the price has been in since 2005. This could mean the business is mature and may begin to decline. However, the only test of that would be a downward breakout. It looked as though such a breakout may be happening a few years ago, but now the price is rising again within the pattern and gives promise of an upside breakout.

On a fundamental level, healthcare is a growing business as the population ages in most of Sonic Healthcare’s markets.

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20.00MOV AVS 12(0) mnth 14.0275 M @ M 100990-300913 SHL - SONIC HEALTHCARE LTD > -0.1% -0.02 to 15.47


Earnings and dividend quality

Earnings per share have increased in the last two years. Dividends increased in the last year.

I would like to see a resumption of strong growth, but this is nevertheless a great business with very steady earnings.


Return on Equity

My Return on Equity graph is constructed using Morningstar data. Mornigstar’s definition of the ratio is Net Profit before abnormals divided by Equity.

The issue here is that the graph shows Sonic Healthcare’s ROE to be below my cost of capital (12.5%) and thus also below my hurdle rate of 15%.

For FY2013, Morningstar calculated the ROE for Sonic Healthcare as 11.6%.

However, when I looked at Stock Doctor, they calculated it as 15.19%.

Normally, I do not worry too much about these differences, which arise from definitions in most cases. However, one ratio clears my hurdle rate and the other does not, so I decided to look further and make my own calculation.

Working backwards from the financial statements, I find that the difference is indeed in definition:

Morningstar’s calculation is:

ROE = Net Profit after Tax and minority interests ÷ Equity excluding minority interests x 100.

Stock Doctor’s calculation is:

ROE = Net Profit before Tax ÷ Total Equity x 100.

Thus, Morningstar’s calculation is after tax and minority interests and Stock Doctor’s calculation is before tax and includes minority interests. There were no significant or abnormal items to consider, but I assume both would adjust their profit figure for them. Nor were there any preference shares in this situation, but I assume that Morningstar would take them out.

There are arguments for either approach. However, I am using ROE to look for companies that earn a return for shareholders - that can be paid to shareholders or reinvested in the business – and that is an after tax return. I therefore prefer the Morningstar definition and will continue to use their data for the graph in future.


Pre-purchase checklist

There is nothing of great concern here, except the Return on Equity, which is lower than I am seeking. That said, the company seems to have a number of cost-out initiatives that may lead to an improvement in the ratio.

I would like Sonic Healthcare to be cheaper (lower PER and higher DY), but it is always difficult to buy great companies cheaply.

DateStock

ASX CodeModelStage

Mkt Av AssessmentPlan Req V Plan

Price Earnings Ratio 18.81 16.22 OK

Dividend Yield 3.91% 4.04% OK

Franking 45% Yes Low

If not fully franked, the dividend yield should be high to compensate. It isn't, but I am investing in this stock for the time being outside my normal investment plan criteria.

Return on Equity 11.6% >15% Low Below my cost of capital (12.5%) and also my hurdle rate of 15%.

Debt/Equity Ratio 68.00% <60% OK Gearing 37.3% (D/D+E) Interest cover 8.6 times, which suggests the debt can be comfortably serviced. Net Debt:EBITDA 2.4.

Mkt Capitalisation $6.2b >$100m OKLiquidity (22-day Av) $20-22m Enough OK

GuidanceExpect EBITDA growth of approximately 5% in FY ’14 (constant currency) - FY ‘14 guidance equates to ~12% EBITDA growth at current exchange rates

CommentsMargin of safety criteria Stock

26/08/2013Sonic Healthcare

SHLGrowth

Breakout starting


Chart analysis Taking a broad view of the sideways pattern, which on my growth model judgement is a consolidation pattern, shows the possible opportunity and the threats.

I have marked on the chart two of the key highs that define resistance levels in the pattern:

1. The most recent significant high in early 2010 and 2. The all-time high in late 2007.

Between them are some highs in 2005 through 2007. So, the price has some work to do to break clear of the consolidation pattern. That it will do so is by no means certain. However, the steady rise over the last two years is providing grounds for taking a position in anticipation.

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Set stops

This chart shows where I have situated my stops. I have based them on the spike low in the broad sideways pattern that formed from mid-2012. That low was $12.50, so my soft stop is one minimum bid lower at $12.49. My hard stop is 2% lower at $12.24.

Updated explanation 16 October 2013 This is in response to a request from a member to provide further explanation on the reasoning behind the stop level I chose. This is a good question, so I have included it here for all members.

To understand why I have chosen this price for my stops, we need to go back to my investment plan.

In Building Wealth in the Stock Market on page 200: “For the first purchase on the breakout from … a consolidation pattern, the sell stop level is situated under the low of the … consolidation pattern.”

So, looking at the monthly chart:

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The consolidation pattern is the price action within the blue rectangle.

The low that would be used as the reference point for my stops is indicated with a red arrow.

The problem with this is that the consolidation pattern is incomplete.

I have bought a rising trend within the pattern, anticipating a breakout will occur. However, that is not a certainty. In that situation, the risk of failure of the trend is higher than usual. In that circumstance, it seemed to me that I should set my stop at a higher level, with reference to the immediate trend and within it.

My stop is marked with dashed lines at the right of the chart. This is under a significant support level within the consolidation pattern. My instinct is that if that level were to be violated, the immediate prospect of a breakout has been sharply reduced.

The member who sent the question suggested that his inclination would be to situate the stops at a higher level than I have chosen – one of the trough lows indicated in blue circles on the weekly chart below, whereas my stops are under the low indicated in the red circle:

My feeling is that this is not an easy chart to analyse for purposes of setting stops. We do not have a breakout and a clear trend. The trend that is there is within a consolidation pattern and has been very choppy.

Hypothetically, using short-term troughs from the bottom in 2010 would have seen me stopped out twice in 2011, with an intermediate re-entry. This is a very common circumstance in sideways choppy markets. It also seems often to be the case with larger stocks.

So, my judgement was to have my stops at a level that I would not tolerate being violated. This comment is for my hard stop in particular.

However, having my stops where they are (only 20% below the current price) is not unusually wide for my investment plan and in any case my position sizing takes account of the risk.


So, one of the problems with the placement of stops in this case is that I am buying in the expectation of a breakout. I have had to think through the implications of that and design a tactical approach that balances risk against potential gain. There is nothing to stop me selling out of the stock before it fell to my stops if the price action from here unfolded in a way that suggested to me that the trend had seriously deteriorated. This could become difficult once the price gets closer to the high of the consolidation pattern and runs into expected resistance.

More generally, placement of stops is not a precise science. It relies on judgement that is born out of experience. It will also have input from our individual level of risk tolerance. Resolving these issues satisfactorily is what the journey from beginner to good investor is all about. I hope this discussion is helpful to members in their investment journey.


Calculate position size

This was an uneventful calculation. To invest 2% of capital, I would risk 0.45% of capital – just short of my maximum allowed risk.

On 26 August 2013 I bought 2,700 shares at an average price of $15.86.

Position size 1st trancheTotal Capital 2,175,679

Buy Price 15.900Hard Sell-Stop 12.240Risk 3.660

% Capital to Invest 2Position it buys 2,737

Max % Capital to Risk 0.5Maximum Position 2,972

Position allowed 2,700

% capital at risk 0.45

% capital invested 2.0


Managing the investment

Updated to 20 November 2013 By 19 November2013, Sonic Healthcare had made some marginal new highs, then made a clearer new high in a down market, which always seems to me to indicate real strength specific to the company:

This was the move I was looking for to justify building my position from 2% of capital to 4% of capital.

This was my position size calculation:

Thus, to invest a further 2% of capital, I am risking a further 0.49% of capital back to my hard stop.

On 20 November 2013, I bought 2,700 shares at an average price of $16.1758.

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18.00W @ D 160109-191113 SHL - SONIC HEALTHCARE LTD > -1.8% -0.30 to 16.38

Position size 1st tranche 2nd trancheTotal Capital 2,175,679 2,185,043

Buy Price 15.900 16.180Hard Sell-Stop 12.240 12.240Risk 3.660 3.940

% Capital to Invest 2 2Position it buys 2,737 2,701

Max % Capital to Risk 0.5 0.5Maximum Position 2,972 2,773

Position allowed 2,700 2,700

% capital at risk 0.45 0.49

% capital invested 1.97 2.00


Updated to 21 February 2014 Sonic Healthcare’s chart has an important feature that I have remarked on in Weekly Market and Portfolio Journals: it is rising from a broad consolidation pattern, but is yet to break above the all-time high reached in 2007 during formation of the pattern. The level of this high is shown by a blue line on the monthly chart:

Because all-time highs are almost always resistance levels, I have been expecting some turbulence around their eventual challenge and therefore been reluctant to move my stops too close in case I am stopped out in this often volatile process, which is normal. However, in more recent months, the weekly chart is showing some clear higher support levels that suggest that should they fail the trend may be in real trouble:

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20.00MOV AVS 12(0) mnth 15.4625 M @ M 280294-280214 SHL - SONIC HEALTHCARE LTD > +2.5% +0.42 to 17.55

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Now that the December trough has been put in place and confirmed by a new high this week, I have decided to raise my stops under that trough:

Low price used to base stops $15.085 Soft stop (one minimum bid lower) $15.07 Hard stop (2% below soft stop) $14.77

I am now set for Sonic Healthcare to challenge the all-time high of $18.08 over the coming months.

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Updated to 27 March 2014 Having been stopped out of RCR Tomlinson, I have been looking to re-establish my close to fully invested positioning in the bull market. Sonic Healthcare has been rising steadily and presented a good candidate by purchasing a final tranche of 2% of capital, taking me to a full 6% invested.

Here is my position size calculation:

On this new tranche, I am risking 0.3% of capital back to my hard stop.

On March 27 2014, I bought a further 2,700 shares at $17.37.

Position size 1st tranche 2nd tranche 3rd trancheTotal Capital 2,175,679 2,185,043 2,348,095

Buy Price 15.900 16.180 17.400Hard Sell-Stop 12.240 12.240 14.770Risk 3.660 3.940 2.630

% Capital to Invest 2 2 2Position it buys 2,737 2,701 2,699

Max % Capital to Risk 0.5 0.5 0.5Maximum Position 2,972 2,773 4,464

Position allowed 2,700 2,700 2,700

% capital at risk 0.45 0.49 0.30

% capital invested 1.97 2.00 2.00


Updated to 4 November 2014 Earlier in this journal I had discussed in detail the issue of where to place stops, especially in relation to my purchase of a growth model stock before it had broken to a clear new high above a consolidation pattern. It now just over a year since I bought my first tranche and at last I feel that I can say Sonic Healthcare has moved decisively above its previous all-time high. This is how the chart looks at the close of 4 November 2014:

Moreover, the recent strong rise has carried the price well above the sideways pattern it has been in for many months. I therefore decided it was time to move my stops up under the low of that sideways pattern:


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20.00EXP MOV AVS 52(0) week 17.1197 W @ W 131109-071114 SHL - SONIC HEALTHCARE LTD > +2.7% +0.51 to 19.17


This is how the new stops look on the chart:

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Updated to 11 November 2014 Following the last update, I decided to update my formal analysis and assessment of this investment. This was not because I was concerned about anything, or that I was considering any action. However, I used it as a test of my updated analysis spreadsheet, which I had adapted to take advantage of the greatly expanded data resource now available in the new version of Stock Doctor that is in the cloud, which has a long term database of financial reports in tabular form going back many years – my spreadsheet only requires 11 years of data, so for a company like Sonic Healthcare, I had all the data I needed in an easily accessible form to input to the spreadsheet. Previously I had been forced to take the data from that number of annual reports, which was a very tiresome exercise.

Business Performance All dollar amounts in the graphs are in millions.

Operating revenue has been rising steadily, albeit with a loss of momentum in 2010 and 2011. However, 2012 saw growth pick up again and it has accelerated somewhat in 2014.

Net Profit After Tax has also grown steadily, but the path has been more volatile. After a sharp fall in 2009, recovery in 2010 – 2011, growth has resumed and picked up in pace in 2014.

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In many ways, EBITDA is a better measure of how the business is performing and the picture here is of more consistent growth, albeit with a pause in 2010-2011. The growth in EBITDA picked up in speed in 2014.

There is always a potential problem with profit measures like NPAT and EBITDA, both of which can be manipulated. Cash is a more reliable measure, so I calculate Free Cash Flow. Free Cash Flow is Operating Cash Flow less Capital Expenditure (Capex). Free Cash Flow has been far more variable and shows less growth overall. Nevertheless, it has been fairly consistent in the last six years. Looking at the underlying data, Operating Cash Flow has not been too much less than EBITDA, which gives confidence in the financial accounting results. The issue that has depressed Free Cash Flow is a consistently high Capital Expenditure. Much of this will be related to Sonic Healthcare’s continual expansion, particularly overseas and the advance of technology. This is not necessarily a problem if the investment is throwing off a high enough rate of return on assets and equity, which I will look at in a while.


Earnings per share grew strongly 2005 through 2009, but then fell back in 2010 and 2011, before rising again. The rate of growth picked up in 2014. Dividends also grew in line with EPS in 2005 through 2009, but were held steady in the following two years before growing again. The payout ratio suggests reasonable security of dividends, considering that this picture includes a difficult time 2009 – 2011.

Financial Risk Financial risk is one of the main risks we have to manage in investing – is the business soundly financed. I start with the working capital ratios, which focus on liquidity.

For a business with a very short activity and therefore cash cycle, this current ratio picture is fine and improving in the last couple of years.

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The quick ratio is probably more pertinent in this business and looks very healthy, mainly because Sonic Healthcare has low inventory and a significant bank overdraft.

I calculate this ratio, but it is of no concern in Sonic Healthcare (a) because inventory is so low (7 to 8 days) in the nature of the business and (b) it is fairly static between 46 and 52 turns.

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This picture is one of it taking longer for Sonic Healthcare to collect its revenue – it was around 40 days and is now around 50 days. This is not a huge concern and may be because of changes in the business, such as how long insurers (incl. Medicare) take to pay, which is not something Sonic Healthcare can control.

Sonic Healthcare is also taking slightly longer to pay its bills, but there is no significant deterioration here that would be a concern.

The other important element in assessing whether a business is conservatively and soundly financed is to examine the debt ratios. I calculated a number of debt ratios below:


Although it has been higher and lower, debt to equity is stable recently around 50%. This is not unreasonable for a non-cyclical business. In fact, the net debt to equity ratio is even lower at around 40%, due to a significant cash holding:

In fact, the net debt to equity ratio is even lower at around 40%, due to a significant cash holding:

Managements prefer this measure because it is always lower than debt to equity and looks better. However, it never fools aware analysts and really gives no further information. It is useful to calculate it because when looking at the investor presentations of competing firms for comparison, this is the ratio they will usually show.

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The other really important debt ratio is interest cover. Usually around 6 times for Sonic, it has moved up to 10 times in the most recent period. Obviously this will be affected by the level of borrowing which will fluctuate significantly around acquisitions.

The other interesting debt ratio is Debt to Free Cash Flow which shows how many years of free cash flow would be needed to repay debt. Clearly, this is a safe position with a major company able to pay its debt back completely in four years if it wished. Of course it will not do that, mainly because its return on equity (see below) is likely higher than its current cost of debt.

This analysis has shown that Sonic Healthcare seems to be very safely financed and there are no trends to cause any concern.

Profitability Since, as an investor, I am buying part ownership of the business, I need to ensure that Sonic Healthcare is operating profitably.

There are no problems here. At 15% and stable the operating margin is relatively high and well controlled.

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The same comment applies to the net profit margin.

Next, we want to look at how well Sonic Healthcare manages its assets. In recent years it is stable around 10%, which shows no adverse trends. However, it has fallen from 11% to 13%. Were it to fall again, it may need investigation.

At 12%, Sonic Healthcare’s ROE is a bit below my cost of capital of 12.5% and below my hurdle rate of 15%. However, there are no adverse trends here and a large established business in such a competitive industry is unlikely to have a high ROE. While I would like it to be higher, this is a long-


term safe and growing industry in which to have exposure. Sonic Healthcare is the most attractive competitor in what is essentially a duopoly in Australia.

Return on equity is higher than return on invested capital, which indicates that Sonic Healthcare’s debt has provided a positive return to shareholders – see my earlier comment on debt.

Liquidity Risk Liquidity of the market for the stock is a significant risk to be managed in investing.

Sonic Healthcare is a large stock and very liquid – at least for my portfolio size.

Price Relative to Value This is now the key question, which goes to the heart of investing with a margin of safety. If we buy a stock at too high a price relative to value, then the strategy is basically one of having to find an even greater fool down the track to sell to at a profit. Moreover, buying at a high price relative to value increases the risk that if something goes wrong, a stock priced to perfection can fall very sharply as the market re-rates its prospects.

So, at the centre of the idea of a margin of safety is to buy at a price that is low relative to value. Price is easy to define, but value is more difficult. There are many approaches to value, but in the end many are relative and it seems that a good approach is to have several different measures. If they all look OK, then we probably have a margin of safety.

Below is my new margin of safety (value) checklist:

LiquidityMarket Capitalisation $7.6BAv traded daily last month $20M


In the top section, one column expresses the various metrics as multiples, which are commonly used in the industry, and the other column as yields, which in some ways make the comparisons easier in terms of return.

This is the picture a few days ago when I did the calculations. However, I bought Sonic Healthcare earlier at better prices. Nevertheless this is useful to look at now and assess. If Sonic Healthcare was now significantly over valued, I might need to consider my position. As it stands now on most of these metrics, Sonic Healthcare appears to be around fair value for a growth model stock.

The dividend yield is low because it is not fully franked due to overseas earnings. Overseas earnings are a tailwind for profits in the current times of a falling Australian dollar. This was a strategic element in my buying this stock.

Margin of SafetyRatios and Yields

Ratio YieldStockCurrent Price: $19.02

All Ordinaries Av PE ratio 19.65 5.09%

Growth model10-year Govt. Bond x 1.5 20.20 4.95%

Stock PE ratio 19.82 5.05%

Stock EV/EBITDA 11.2 8.93%

Stock EV/ Free Cash Flow 22.9 4.36%

Dividend Yield Stock All Ords AvDividend Yield 3.52% 4.25%Franking 51% 80%Grossed up Dividend Yield 4.29% 5.71%

Sonic Healthcare


Updated to 18 March 2015 Since I last reviewed the chart and raised my stops on 4 November 2014 the share price fell abruptly in the second half of November 2014:

However, this sharp correction was soon countered by a steady rise through December 2014:

By the eve of the announcement of Sonic Healthcare’s half-year 2015 earnings report on 17 February 2015, the share price had surged to a new high for the trend:

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Since then, the share price has made a marginal new high just shy of $20 and seems to be consolidating between $19 and $20.

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I do not see a clear higher trough in the trend that would enable me to raise my stops at this time.

Next, I need to update my analysis of the business performance…

Financial Risk and Liquidity

Working Capital

These ratios have strengthened slightly in the last period.

Not really relevant for this company – shown for completeness.

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Receivables are slowly rising, but the level is not a concern. Likewise, payables.

Debt and Equity

Debt has increased a bit, but is not a concern for this business.

Interest cover is strong and strengthening.


Debt to EBITDA is fine. Debt to free cash flow fluctuates with capex and purchase of subsidiaries, but is not a concern.

Profitability

Trend of Sales and Earnings

Sales revenue is rising steadily.

However, statutory profit was down slightly in the most recent period.

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Growth in EBITDA has also stalled in the last period. Cash flow fluctuates rather more, but does not suggest a problem.

Level and Trend of Profit Margins

Gross margin is slipping steadily. However, net margin, though down in the last period, is fairly static over the last six years.

Shareholder Return

All these returns are fluctuating in a range over the last six periods. Return on equity is still a bit below my cost of capital of 12.5% and below my hurdle rate of 15%.


Margin of Safety: Price versus Value

Sonic Healthcare is not as good value as it was, but of course, I bought at lower prices. I see no reason not to continue to hold it. Also since I have invested 6% of capital in it, I have no room in my investment plan to buy more.

Ratios YieldsChart Model GrowthMarket-based Criteria10-year Govt. BondPrice/Coupon 0.00 Coupon/Price x

All Ordinaries AveragePrice/Earnings 15.45 Earnings/Price 6.47%

Data for Sonic HealthcareMarket Price $19.85

Price/Earnings 20.97 Earnings/Price 4.77%

EV/EBITDA 13.0 EBITDA/EV 7.68%

EV/ Free Cash Flow 33.4 Free Cash Flow/EV 2.99%

My Plan StockCost of Capital 12.5% Return on Equity 12.00%My Hurdle Rate 15.0% Recent ROE trend flat

All Ords Av StockDividend/Price 5.29% 4.29%Grossed up Dividend Yield

Margin of Safety - Price versus Value

Return on Equity v Cost of Capital


Updated to 1 April 2015 Since the last review in Mid-March 2015, Sonic Healthcare’s share price has broken through the $20 mark:

My stops are in the right place on my investment plan and I am fully invested in this stock, so no action is called for at this time.

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Updated to 15 May 2015 When I last reviewed the chart of Sonic Healthcare its stock price was only days from making a high from which it has retreated over the last six weeks:

I judge my stops to be in the right place on my investment plan, so no action is required based on the chart at this time.

There has been no significant news on the stock recently. The decline in the stock price is consistent with the correction in the overall market. There has also been some ongoing concern about possible government policy changes that may impact on its business.

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Updated to 26 June 2015 On 15 June 2015 Sonic Healthcare announced a significant expansion by acquisition in Switzerland (key information highlighted):

This news was well received by the market with the price rising to a new high over the following days:

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30.00EXP MOV AVS 12(0) mnth 19.2167 M @ M 310795-300615 SHL - SONIC HEALTHCARE LTD > -1.2% -0.26 to 21.44


I am in two minds about raising my stops at this point. Perhaps if the new high is more clearly established I will, but I am wary about the tendency of downward spikes in this stock and the knowledge that we are in a period when markets tend to be volatile and lacking upward momentum.

So, no action at this point.

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24.00EXP MOV AVS 52(0) week 18.9673 W @ W 090710-260615 SHL - SONIC HEALTHCARE LTD > -1.2% -0.26 to 21.44


Updated to 30 July 2015 On 6 July 2015, Sonic Healthcare announced its continuing growth in Europe by an acquisition in Belgium:

Since my last review, Primary Heath Care issued a negative profit warning. This seems to have led to speculation about and a fall in the share price of Sonic Healthcare, since they are the two major players in Australia. On 20 July 2015, Sonic Healthcare issued the following earnings guidance:

Clearly, this explains the recent falls in the share price. Sonic Healthcare is due to report on 10 August 2015, at which time we will have a clearer picture.

2015 had seen two strong rises in the share price and the sharp recent fall around this earnings guidance has brought the price back into the general slope of the rise since 2012:


I am happy to leave my stops where they are for the moment, However, I would have to reassess the situation if the price was to fall significantly through the last trough, because it may constitute one of my alternative sell signals.

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Updated to 19 August 2015 Since my last update, on 14 August 2015, Sonic Healthcare announced the loss of a pathology contract in Alberta after a change in government:

Clearly this was a disappointment, but it had not been included in Sonic Healthcare’s most recent earnings guidance.

On 18 August 2015, Sonic Healthcare announced its full year earnings. Some of the more pertinent slides from their investor presentation were:


And updating the company profile:

This has obvious implications for franking credits going forward.




I can now update my analysis of the Sonic Healthcare accounts:


Sales revenue showed another good increase, but a bit less than the previous year.


Statutory profit was down due to the regulator changes in Australian pathology and costs of reorganisations.

Likewise EBITDA and cash flows.

Financial Risk and Liquidity

Working Capital

Both ratios strengthened last year.


This is shown for completeness – not relevant for Sonic Healthcare.

Both receivables and payables days increased slightly.

Debt and Equity

Debt has increased with recent acquisitions, but is still manageable.

Evidenced by a strong net interest cover.


These measures have weakened a bit, but are still manageable.

Profitability


Both gross and net margins slipped last year – this is of more concern if it is not arrested. It could reflect acquisitions in lower-margin areas.

Shareholder Return

All three return measures have slipped in the last year, which is a concern. Debt contributes strongly to return on equity.


Earnings per share have slipped, but the dividend advanced, which has tightened the payout ratio.

The payout ratio relative to free cash flow has also tightened a bit in the last year.

Margin of Safety: Price versus Value

Sonic Healthcare is no longer as cheap as when I bought into it.

Of more concern is that return on equity has fallen further below my cost of capital.

Ratios YieldsChart Model GrowthMarket-based CriteriaAll Ordinaries AveragePrice/Earnings 15.53 Earnings yield 6.44%


Price/Earnings 22.78 Earnings yield 4.39%

EV/EBITDA 14.3 EBITDA yield 7.00%


My Cost of Capital 12.5%Return on Equity 11.4%Recent ROE trend fluctuating



The dividend yield is not outstanding value now, but is of course better on my purchase price.

Market Liquidity

Sonic Healthcare is a large stock with a very liquid market.

Timing and Risk Management

Chart Analysis

All Ordinaries index Average 5.94%Sonic Healthcare 4.10%

Grossed up Dividend Yield

Market LiquidityMarket Capitalisation $m 8,462Av Buy/sell spread % 0.1Annual Turnover % 83.6Annual Turnover $m 7,074Av trade/day last year $000 28,297Av trade/day last 20 days $000 30,911Top 20 Ownership % 72.2

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The share price has come off its peak after the effect of Australian pathology regulatory change was realised.

Review Stops

This is a great business. Although the margins are under some pressure in the short term, I am relaxed about where my stops are. Were it to be a lesser quality business, I might be more inclined to raise my stops under the mid 2015 lows. I am also cognisant that we may see more volatility between now and October-November. Tight stops might throw me out of a good stock unnecessarily.

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Updated to 2 December 2015 Since the last update, the company held its Annual General Meeting.

There were important two points highlighted in the Chairman’s address:

The Chief Executive Officer gave a trading update to October:

Also, he affirmed guidance for the current year:


This slide from his presentation gives a good picture of the UK operations:

And this slide for Germany:


This was the outlook statement:

Sonic Healthcare’s share price suffered a greater than expected correction since the last review. However, it held at support and well above my stops and has now bounced back nicely:

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No action is necessary on my investment plan at this time.

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Updated to 1 February 2016 On 16 December, Sonic Healthcare issued a statement with respect to proposed Medicare regulations:

The government proposals have had a sharp impact on the share price:

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The fall rounded out above my stops and there has been a positive bounce.

I think it can be argued that the last drop in the share price could have been seen as one of my alternative sell signals. I gave it some thought, but decided that I would stay with my established stops and see how it pans out. Sonic Healthcare is a great business and I am reluctant to let it go. However, if my stops are hit, I will sell it without hesitation.

I know that many members will have made different decisions. I think it is entirely reasonable to consider that I should have raised my stops some time ago under the low of the trough in mid-2015. That would have taken me out on the first slide. As mentioned above I might also have sold on the last slide. These are matters of interpretation and judgement. Hindsight is always far clearer than foresight at the time.

As of the close on 1 February 2016, I have a total return over two and a half years of 22.5%.

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Updated to 1 April 2016 Since the last update Sonic Healthcare has announced its interim report. Some useful slides from the investor presentation:





Below is my analysis of the interim report. 2016 flow date have been annualised.


Revenue continues to grow strongly.


However, it has not been smoothly translated into statutory profit.

Likewise at EBITDA level.

Operating cash flow has been somewhat more volatile.


As has free cash flow. The fall in the last period was caused by increased capital expenditure.

Financial Risk

Working Capital

No problem here.


Not relevant for this business.

The recent upward drift seems to have been curtailed in the last period.

No problem here.

Under control.


Fluctuates quite a bit from year to year. I would like to see the recent trend reversed.

Debt and Equity

The increase in 2015 has not been reversed as Sonic Healthcare continues with growth through acquisition. I am not overly concerned with the debt level.


Ideally I would like to see debt moved lower, towards two times EBITDA.

The blowout here is due to increased capital expenditure.

The most important debt ratio remains strong.

Profitability



Margins remain strong.

Shareholder Return

Return on assets is sliding lower. This is a trend I would like to see stabilised or reversed.

Likewise here.


Earnings per share lack consistent upward momentum. Interim dividends were increased slightly.

Payout ratio fluctuates, but seems appropriate for this business.

The dividend remains covered by free cash flow.

Summary: Price versus Value and Returns

60

65

70

75

80

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Payout Ratio %


Sonic Healthcare is no longer cheap, but is not strongly overvalued.

Return on equity is slightly below my required rate of return. For this reason I prefer the high payout ratio.

The dividend yield is OK for a growth stock.

This is a somewhat patchy picture. Of particular concern is the decline in return on equity.

Market Liquidity

RatiosChart Model GrowthMarket-based CriteriaAll Ordinaries AveragePrice/Earnings 14.60


Price/Earnings 18.89

EV/EBITDA 12.3


My Cost of Capital 12.5%Return on Equity 11.2%Recent ROE trend flat



My Average Cost $ 16.48Dividend per share $ 0.71Effective yield 6.15%


Growth % 10 Years 5 Years

Operating Revenue 146.3% 38.5%Earnings per Share 48.4% 20.4%Return on Equity -20.1% -8.6%Dividends per Share 54.3% 20.3%Free Cash Flow 90.0% -13.1%


Sonic Healthcare is a large and very liquid stock.

My overall conclusion here is that this great company has some areas of concern. I need to watch it closely going forward.

Timing and Capital Preservation

Chart Analysis

Not much has changed since the last review:


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The strong uptrend has morphed into a correction very much in line with the overall market. I see no reason to move my stops at this time.

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Updated to 28 July 2016 Since the last review there have been no news announcements for Sonic Healthcare.

The share price has moved up strongly, though:

I could tweak my stops by moving them marginally to under the December 2015 low, but it does not seem worth doing.

Sonic Healthcare is due to release its full year earnings report on 17 August 2016.

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Updated to 19 August 2016 Since the last update Sonic Healthcare has announced their full year earnings report. The investor presentation updated some segmental data:




My analysis of the report follows below:



Strong growth in sales revenue

And in statutory profit

Which flowed through from EBITDA


Operating cash flow was also strong

Free cash flow was a weaker rise due to capex growth

Financial Risk

Working Capital

Working capital liquidity looks fine


The company holds little inventory – shown for the record

Receivables days has improved slightly after the previous year rise

Likewise, payables


Cash conversion improved

The rise in days working capital has been arrested

Debt and Equity

Debt has been reduced slightly


The leverage ratio has been reduced again

Likewise against free cash flow

Interest cover remains very strong.


Profitability


Margins improved slightly

Shareholder Return

Return on assets lifted off a prior year low

Return on equity improved after a dip, boosted by use of debt.


Earnings per share echoed profit growth and dividends were increased.

The payout ratio was at a 10-year low.

Dividends are well covered by free cash flow.



Sonic Healthcare is no longer as cheap as when I bought it, but it does not seem overly expensive for such a great business.

Return on equity is back at my cost of capital

Dividend yield is low due to restricted franking, but is healthy against y cost.




EV/EBITDA 12.9


My Cost of Capital 12.5%Return on Equity 12.6%Recent ROE trend varies






Market Liquidity

Sonic Healthcare is very liquid.


Chart Analysis

The share price did not move much on the announcement and remains near an all-time high:


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There is no need at present to raise my stops – see comment at the last review.

The company gave the following guidance in their investor presentation:

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Updated to 23 November 2016 Some highlights from the Annual Report:

On 4 November 2016, Sonic Healthcare announced a new acquisition:


On 8 November 2016, Sonic Healthcare announced the expansion of its ownership in another German acquisition:


2017 Guidance was confirmed at the AGM:


Some other slides from the AGM:


The Sonic Healthcare share price has been quite volatile in the last two years, but keeps pushing to new all-time highs periodically:

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I have decided to move my stops up marginally beneath the late-2015 low:



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Updated to 14 March 2017 On 30 January 2017 Sonic Healthcare announced another German acquisition:

On 7 February2017 Sonic Healthcare announced partnerships with two USA hospital groups:


Following is my analysis of the interim report. Flow data for the latest period have been annualised.


Sales growth has slowed noticeably in the latest period.


This is reflected in gross profit.

And in statutory profit

And operating cash flow reflected this.


Free cash flow dropped from a peak in the previous period due to an increase in Capex.

Financial Risk

Working Capital

Working capital liquidity was basically steady.

This is not an important ratio for this company


An adverse trend in receivable control has been reversed

Payables crept out slightly again. No sign of problems.

Debt and Equity

Debt edged up very slightly


But interest cover remains strong.

The leverage ratio is nudging 2.5 times again. No problem so far. It has been a bit higher in the past.

Debt to free cash flow looks fine, though one hopes it will not go much higher.


Profitability


Global profitability margins remained steady.

Shareholder Return

Return on assets is within the nine-year range.


Return on equity and capital were steady.

The earnings were unchanged and the dividend edged up.

The payout ratio was essentially steady


Free cash flow covers the dividend


Sonic Healthcare now looks fully priced.

Return on equity is steady at mu cost of capital.




EV/EBITDA 12.1


My Cost of Capital 12.5%Return on Equity 12.6%Recent ROE trend steady



The dividend yield is lower than the broad market, but OK on my cost.

Market Liquidity

Sonic Healthcare stock has a very liquid market


Chart Analysis

Sonic Healthcare’s stock price has been trading sideways, reflecting the interim earnings report





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I see no reason to raise my stops, but may be concerned were the price to drift below the late 2016 low.

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Updated to 28 August 2017 Sonic Healthcare has announced its full year results. Some slides from the chief executive presentation:



My analysis of the financial results follows:



Revenue growth subdued due to currency movement.

Likewise gross profit

And statutory net profit slipped back a bit


Operating cash flow advanced slightly

Free cash flow reduced by high capex, which is now tailing off

Financial Risk

Working Capital

Both working capital liquidity ratios are within the ten year range


Inventory is not material for this business

Credit control is steady

Trade debts are gradually being paid more slowly. I don’t see this as a problem.


Cash conversion has strengthened over the last two years

Working capital turnover is low and fluctuates between positive and negative

Debt and Equity

Debt ratios look OK in total and have been trimmed slightly in the last two periods


Interest cover remains strong

The leverage ratio also remains strong

Notwithstanding the high capex, the free cash flow cover is also quite strong and should improve next year as capex tails off


Profitability


Global margins have tightened over the ten year period shown. This is a trend that I would like to see arrested.

Shareholder Return

Return on assets has declined slowly over the ten years. This may reflect changes in the structure of the business with many acquisitions.


Return on capital and equity remain within the ten-year range

EPS came off the2016 peak. Dividends were increased again

The payout ratio fluctuates either side of 70%


Free cash flow continues to cover the dividend


Sonic Healthcare is a growth stock and is above the market average PE ratio as might be expected.

The return on equity is a bit below my cost of capital




EV/EBITDA 12.1





The running dividend yield is below the market average as might be expected. My yield on cost is stronger.

Market Liquidity

Sonic Healthcare remains a large stock with a liquid market.


Chart Analysis





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I would like to move my stops up under the late 2016 low, but Sonic Healthcare has not made a sufficiently strong new high to define it as a trough in the trend. Nevertheless a drop below it might be seen as one of my alternative sell signals, a judgement I will need to make at the time considering how and why the price got there.

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Updated to 5 March 2018 Since the last update, Sonic Healthcare have announced their interim earnings report. My analysis of it follows. Flow data have been annualised.


Sales revenue continued to increase, albeit slowly

Likewise, gross profit


However, statutory profit has been essentially flat for the last three periods.

Operating cash flow continued its gradual upward path

Free cash flow increased strongly driven by reduced capex


Financial Risk

Working Capital

These working capital liquidity ratios look fine

Inventory turnover is within the ten year range. This is not an important ratio for this company.

Trade debt collection has improved, showing good credit control.


Trade debt payments have been a little faster after the peak in 2017.

Debt and Equity

Indebtedness has increased, but looks manageable

Interest cover remains strong.


The leverage ratio has spiked up, but remains within the ten-year range.

Debt to free cash flow was down driven by higher cash flow due to lower capex.

Profitability


Margins remain steady, though they show signs of being under constant pressure over the ten-year period.


Shareholder Return

Return on assets showed minimal growth

Both ratios remain in the ten-year range, but look to be under pressure. Use of debt contributes.

Earnings per share were essentially flat for the last three years. Dividends are creeping ahead progressively


The payout ratio was little changed

Free cash flow increased due to lower capex and covered the dividend comfortably.


Sonic Healthcare continues to look fully priced




EV/EBITDA 13.3



Return on equity is somewhat below my cost of capital

The running yield is below the market average as would be expected for a growth model stock. My effective yield is quite strong.

Market Liquidity

Sonic Healthcare is a large stock and has a very liquid market.

My Cost of Capital 12.5%Return on Equity 11.6%Recent ROE trend flat








Chart Analysis

Since the last review, Sonic Healthcare has made a marginal new high.

My investment plan does not mandate that I move my stops at present, though I will have to look closely if the late 2017 or 2016 lows were to be taken out.

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Updated to 17 August 2018 Sonic Healthcare reported its annual profit yesterday. I am waiting for Stock Doctor to post the financials before I can analyse it. In the meanwhile, I noticed that I should have raised my stops some time ago, so have done that now:



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Updated to 21 September 2018 The following is my analysis of the Sonic Healthcare annual report:


Sales revenue was up strongly

As was gross profit

And statutory profit, after a slight dip last year


This was reflected in operating cash flow

Free cash flow was up sharply based on reduced Cap Ex.

Financial Risk

Working Capital

The current ratio was up strongly, while the quick ratio was a bit lower than last year. No problem.


Inventory is not material for Sonic Healthcare and is shown for the record.

Receivables have been reduced slightly again – no evidence of problems.

Likewise payables


Debt and Equity

Debt has increased somewhat, but is still within the decade range.

Interest cover has reduced a bit, but looks strong.

The leverage ratio has increased again this year. I would be more comfortable with it if brought back to 2.5 times at the most.


Debt to free cash flow is lower, mainly because Capex was down.

Profitability


Margins remain under pressure in the industry, but have held up well.

Shareholder Return

Return on assets was flat with the low level last year.


Both measures are just within the decade range.

Both earnings per share and dividends per share were at new record highs for the decade.

The payout ratio was within the range of the ten years shown.


Free cash flow was up because of a drop in Capex. The dividend is well covered by free cash flow.


Sonic Healthcare looks relatively expensive, but this is to be expected in a high-quality business.

Return on equity was steady and just below my cost of capital.

The running yield is below the market average, but my effective yield is strong.




EV/EBITDA 13.7








Market Liquidity

Sonic Healthcare is a large stock with a liquid market.


Chart Analysis

The long uptrend from the 2010 low continues.


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I see no cause at this time to move my stops up any further.

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Completed 14 November 2018

For a few days Sonic Healthcare had traded close to my stops – in fact in the gap between my soft and hard stops:

Early on 14 November 2018 I checked it and it had traded below my hard stop ($22.02).

I sold it quickly and easily in a liquid market at an average price of $22.143, which was better than my hard stop, but my plan calls for me to sell once a stock trades below my hard stop.

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Outcome of the investment

Evaluation against investment plan Model identification

Correctly identified as growth model

Capital invested

6% in three tranches

Diversification

I also had 6% of capital invested in Ramsay Health Care

Max % capital risked

2%

Liquidity

Sonic Healthcare had a deep liquid market

Buy signal

Breakout from long sideways pattern

Margin of safety

I consciously made this investment somewhat outside my plan. It is always difficult to buy great stocks cheaply.

Position building

Two tranches of 2% of capital

Sell-stop and sell signal

Fell through my hard stop

Result of investment $ %Total sale proceeds 179,179.15less Total purchase cost 133,455.00Realised capital gain/loss 45,724.15 57plus Dividends & Franking Credits 34,774.00 43Net total return 80,498.15 100% of capital 3.70


Repurchase 15 February 2019 It now seems that the correction in the bull market has been well and truly completed. Sonic Healthcare is one stock which I sold because it had violated my stop – correctly following my plan. Reviewing the chart, it seems that my stop may have been way too close. The chart now looks like this:

Sonic Healthcare is a great long term growth story. I think I should be holding it with more room back to my stop than I had previously. On the weekly chart above, the obvious failure point for the big trend is the December 2015 low:


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This was my position size calculation:

As can be seen from this calculation, because my stop is so far below the price, to stay within 1.5% of capital risked, I could only invest 5% of capital at a price of $23.64.

On 15 February 2019, I bought 5,100 shares at an average price of $23.68.

Position size 1st trancheTotal Capital 2,434,608

Buy Price 23.640Hard Sell-Stop 16.490Risk 7.150

% Capital to Invest 6Position it buys 6,179

Max % Capital to Risk 1.5Maximum Position 5,108

Position allowed 5,100

% capital at risk 1.50

% capital invested 4.95


Updated to 4 March 2019 The following is my analysis of the interim report. Flow amounts from the interim report have been annualised.


Sales revenue increased again.

This flowed through to higher EBITDA.

Statutory profit also increased.


Operating cash flow crept up again.

Free cash flow held the big gain in the previous year and it increased again by a bit.

Financial Risk

Working Capital

Working capital is as strong as it has been in the decade.


Inventory turnover is not that important for Sonic Healthcare and turnover of stock deteriorated, it has been in that range a decade ago.

Debt collection has hit a new low for the decade.

Sonic Healthcare also paid creditors slightly more quickly.


Debt and Equity

Debt measures have improved slightly.

Interest cover is essentially unchanged.

The leverage ratio was slightly reduced.


The same for debt to free cash flow

Profitability


Gross and net margins held satisfactorily

Shareholder Return

Return on assets slipped slightly on the previous year and over the last three years is lower than earlier in the decade.


Return on invested capital is essentially stable on the previous year, but near the low for the decade. Return on equity slipped somewhat. Use of debt has increased the return on equity.

However, earnings per share were up slightly again and the dividend per share also edged higher.

The payout ratio is again just below 70%


Free cash flow increased a bit and covers the dividend by a good margin.


Sonic Healthcare’s PE ratio is above the market average as may be expected for such a strong business.

Return on Equity v Cost of Capital My Cost of Capital 12.5% Return on Equity 10.4% Recent ROE trend down

Return on equity has slipped a bit against my cost of capital. I would like to see this measure increased going forward.




EV/EBITDA 13.6



The dividend yield is lower than the market average as might be expected for such a strong business.

Market Liquidity

Sonic Healthcare has a big liquid market in its shares.


Chart Analysis





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Sonic Healthcare shares are in a long-term upward trend. As mentioned earlier, my stops are now not crowding the trend as it was before.

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Updated to 25 June 2019 Since I repurchased my initial position in Sonic Healthcare, it has risen nicely and the charts now look like this:

I think that I can move my stops up under lows established late 2018 and early 2019:

Low price 21.26

Soft stop 21.25

Hard stop 20.83

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This has enabled me to purchase an additional 1% of Sonic Healthcare, building my position to 6% of capital.

On 25 June 2019 I bought another 730 shares at an average price of $27.4598.

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Updated to 19 September 2019 Following is my analysis of the annual report for 2019.


Beautiful trend in sales

And in gross profit


Flowing through to statutory profit

Excellent trend in operating cash flow

Free cash flow is up again, but has been more variable


Financial Risk

Working Capital

No problem in current liquidity

Shown for the record – Sonic has very little inventory structurally

After blowing out to 54 days to collect trade debts, it is back in the mid 40s


A very stable picture in payment of trade debts

Debt and Equity

Overall debt levels are at decade lows

Interest cover is strong at nearly 10 times


Debt fluctuates between 2 and 3 times EBITDA and is sitting now at the lower bound

Debt to free cash flow is at about a decade low

Profitability


Profit margins have improved in the last year after slipping in the prior 4 years


Shareholder Return

Return on assets had fallen over the decade, but is edging higher recently.

Return on equity has eased a couple of percent in recent years. Return on invested capital has fluctuated either side of 8%.

Earnings per share and dividends show a steady growth.


Free cash flow covers the dividend by a good margin.


Sonic Healthcare is not cheap as one might expect from so sound an investment.

Return on equity is down a bit, but above my cost of capital.




EV/EBITDA 13.3


My Cost of Capital 12.5%Return on Equity 10.7%Recent ROE trend down



Dividend yield is somewhat below the market average and is not fully franked.

Market Liquidity

Sonic Healthcare has a very liquid market.


Chart Analysis




Market LiquidityMarket Capitalisation $m 13,301Av Buy/sell spread % 0.1Annual Turnover % 58Annual Turnover $m 7,715Av trade/day last year $000 30,858Av trade/day last 20 days $000 27,475Top 20 Ownership % 71.4

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Sonic Healthcare’s stock price is trending upward strongly.

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Documents

Important - bwts.com.au · Mkt Av Assessment Plan Req V Plan Price Earnings Ratio 18.81 16.22 OK Dividend Yield 3.91% 4.04% OK Franking 45% Yes Low If not fully franked, the dividend