No-moat Healius (ASX: HLS) detailed its strategy to expand group EBIT margins to high single digits by June 2027. We leave our $2.20 per share fair value estimate and earnings forecasts broadly unchanged. We forecast a group EBIT margin of 7% in fiscal 2027 and anticipate the firm expanding this further to 10% by fiscal 2034.

Despite rallying 11% on the strategy day, shares are materially undervalued. We are likely more optimistic than the market about the group’s ability to improve profitability. Longer-term, we anticipate that increased operating leverage from higher volumes and a continued focus on labor productivity and rostering more than offsets wage inflation. All else equal, we would have to assume a midcycle EBIT margin of 6% for our fair value estimate to be close to the current share price.

Healius is targeting total annualized cost savings and efficiencies of roughly $50 million in incremental EBIT by June 2027, which we assume is achieved in our forecasts. Nearly half is related to rationalizing corporate costs and securing better procurement of consumables. The remainder is mainly due to streamlining workflows through digital initiatives, network utilization, and mix shift to higher-value pathology tests such as gene and veterinary testing.

Healius increased pathology revenue from July 2024 to February 2025 by 6%, in line with our unchanged full-year forecast of 6%. Healius is adding new digital self-service features for doctors to query pathology reports and is continuing to roll out its collector portal, which guides collectors and reduces errors. Healius also now offers general practitioners a new automated way of capturing continuing professional development, or CPD, points. The upside for these efforts is that it likely helps Healius build its referrer base while reducing referrers’ reliance on its call centers. Healius estimates a further $20 million in abnormal digital investment split evenly between the remainder of fiscal 2025 and fiscal 2026.

Healius to become pure play pathology provider

In 2018, the former Primary Healthcare rebranded itself as Healius to signify the strategic turnaround underway. Healius is looking to new sources of strategic growth as well as dealing with prior underinvestment in infrastructure. There is much to fix in the business and we anticipate it to take a few years before significant margin improvements are made in the base pathology businesses. Healius selling its medical centers and Montserrat day hospitals to focus on redirecting capital toward infrastructure upgrades and its diagnostic businesses is viewed as a positive strategic step. The impending sale of the Lumus Imaging also simplifies the business and shores up the balance sheet.

Improvement in systems is key to improving efficiency. Pathology is an increasingly technologically driven service and the company intends to invest in a new laboratory information system, automation, and digitization through to fiscal 2024. However, while we view the system upgrades as necessary to restore earnings growth, we don’t see the company building an advantage over rival Sonic Healthcare, which is also continuously improving its systems.

Virtually all revenue is earned directly from Medicare via bulk-billing in the pathology segment. Healius’ organic volume growth in its core pathology segment has typically ranged between 3% and 5% and we forecast a similar rate over our 10-year forecast period. The volume growth is underpinned by population growth, aging demographics, higher incidence of diseases, and wider adoption of preventive diagnostics to manage healthcare costs. In addition, the number of tests available is expanding. Increasing complexity of tests, such as veterinary and gene-based testing, is also resulting in average fee price increases. Pathology has a high fixed cost of operation and thus benefits from volume growth to drive lower cost-per-test outcomes. Higher testing volumes result in a lower cost-per-test as labor, equipment, leases, transportation, and overhead costs are all leveraged. In 2013, the Australian government placed a freeze on Medicare fee rates but resumed indexation in fiscal 2021 for diagnostic imaging.

Healius bulls say

  • On top of the base level of covid-19 testing that is likely to continue, Healius is well-positioned for underlying trends in preventive diagnostic treatments.
  • Simplifying the business via the sale of its medical centers is a positive indicator for the ultimate success of the company’s turnaround.
  • Advances in technology and personalized medicine are increasing the number of complex and gene-based tests available to patients, which are typically higher-margin.

Healius bears say

  • Elevated covid-19 testing is moderating and operating leverage is expected to unwind as earnings normalize.
  • Virtually all revenue is Medicare linked and pricing and regulatory scrutiny on this revenue stream is expected to persist.
  • Healius neither currently earns a return on invested capital above its 8.5% weighted average cost of capital, nor do we expect it to in a typical year over our forecast period.

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