Healius Limited

  • Moat Rating: None
  • Share Price on 24/09/2024: $1.70
  • Fair Value: $2.50
  • Price to Fair Value: 0.68 (Undervalued)
  • Uncertainty Rating: Medium

What is the deal?

The second-largest pathology operator in Australia, Healius Limited HLS has recently agreed to sell its imaging business, Lumus Imaging to Affinity Equity Partners. The sale represents a total consideration of $965 million with cash proceeds estimated to be around $835 million.

The sale of Lumus which accounts for almost half of the fiscal 2024 group operating earnings represents a shift to a purely pathology focus for Healius.

Morningstar reduces our fair value estimate by 17% to $2.50, with Affinity Equity Partners paying a premium at 25.0x fiscal 2024 EBIT which is over Healius’ current earnings multiple for Lumus.

Despite this premium, we believe it isn’t enough to offset the lost value of future earnings that we expect from Lumus’ material operating margin improvement. Even though Healius no longer stands to benefit from this, our analysis indicates the market still underappreciates the potential for margin improvement in the core pathology business and shares currently trade at a considerable discount to our intrinsic investment.

Why sell?

A key motivation for the sale was Healius’ stretched balance sheet with net debt/EBITDA and interest cover that sat just within the covenants. The firm struggled with the flexibility and capacity to invest in both imaging and pathology after an on-market share buy back of $200 million in 2021 when profits were soaring thanks to Covid-19. After the dilutive action of 2023’s $187 million raise, investors would have balked at the prospect of another event.

However, thanks to Affinity, this sale has shored up Healius’ balance sheet with sales proceeds paying off approximately $200 million in debt (roughly half its FY24 outstanding debt), leaving the company in a net cash position.

Affinity on the other hand, stands to benefit from forecasted improvements in Lumus’ operating margin to a midcycle 14% up from 9% in fiscal 2024.

What will Healius do with the money?

After this transaction Healius will be in a net cash position of around $400 million. Some proceeds will fund investment in the pathology business and refinance its debt facilities. Capital returns in the form of buybacks or dividends should be material with a midcycle forecast dividend payout ratio of ~60%.

We assume surplus capital will be returned to shareholders through dividends. If Healius instead choose to repurchase shares, this may prove materially value accretive. If all surplus capital was directed to buybacks at the current market price, our fair value estimate would increase to around $3 per share.

Where does this leave Healius?

Second to Sonic Healthcare, the colossal pathology operator, Healius is still unable to set prices and exploit cost advantages due to its weaker relative market position. Healius’ pathology business is significantly smaller than Sonic’s and operates with weaker scale efficiencies and aging physical and digital infrastructure.

Healius is looking to execute on its redefined pathology strategy through reinvestments to upgrade its business. While we expect this to narrow its relative disadvantages with the potential for high returns, Sonic will maintain a significant cost advantage derived from its superior and growing scale.

It is likely that Healius may also remain the laggard as Sonic simultaneously continues to upgrade its systems, therefore we establish that Healius has no moat.

Why we’re still bullish despite the price downgrade

While the business was sold at a premium over Healius’ earnings multiple at the time, we believe this wasn’t adequate to offset the lost value of Lumus’ future forecast earnings and consider the deal to be value destructive.

Healius still presents as an opportunity at its current price due to the improvement of Healius’ balance sheet, but also the simplification of the business, allowing the company to focus on pathology system upgrades to restore earnings growth.

After the sale of Lumus, pathology is the key revenue source for the business with a 10-year CAGR of 5% and EBIT margins expected to expand to 12% by fiscal 2024 from 5% in the second-half 2024. After a projected debt repayment of ~50% outstanding debt, Healius is still left in a net cash position with leverage ratios easing to safe levels, coming down from just below their covenants.

Financial risk is low given low revenue cyclicality and solid cash conversion. We forecast the company to be net-cash for most of our ten-year explicit forecast period, while also funding its organic growth and maintaining a 60% dividend payout ratio.

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued. 

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica. 

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.