This equity raise looks extremely attractive
We recommend participating in the retail offer, providing it is consistent with your financial goals.
Mentioned: Healius Ltd (HLS)
Key metrics for Healius
Morningstar Rating: 5 stars
Morningstar Economic Moat Rating: None
Morningstar Uncertainty Rating: Medium
Morningstar Capital Allocation Rating: Standard
Healius (ASX: HLS) will raise a total of $187 million from an underwritten institutional and retail entitlement offer. The equity raising represents an additional 156 million shares, or 27% of shares on issue. While dilutive to EPS, all new shares are to be issued at $1.20, a 29% discount to the theoretical ex-rights price, and a 60% discount to our fair value estimate of $3.
Healius is Australia’s second-largest pathology provider and third-largest diagnostic imaging provider. Pathology and imaging revenue is almost entirely earned via the public health Medicare system. Healius typically earns approximately 75% of revenue from pathology and 25% from diagnostic imaging.
Healius intends to primarily use the raised capital to reduce its total drawn debt. At fiscal 2023 year-end, leverage was elevated. Net debt/EBITDA was at 3.5, but remained below the temporarily increased 4.0 debt covenant.
Healius’ debt providers have agreed to waive the debt covenant for first-half fiscal 2024 and temporarily increase the debt covenant again to 4.0 from 3.5 at June 30, 2024.
The waiver is based on a commitment from Healius to reduce its drawn debt by at least $150 million by June 30, 2024. Healius will also not declare or pay any dividends in fiscal 2024.
Following the raise, we forecast leverage to reduce to 2.1 by fiscal 2024 year-end and remain at a comfortable level.
Given the near-term impact on labor productivity as it transitions its workforce away from pandemic testing, together with higher interest rates and inflationary pressures on its predominantly fixed cost base, profitability is expected to remain depressed near-term.
We expect dividends to be reinstated in fiscal 2025 at a 60% payout ratio.
We recommend participating in the retail offer, providing it is consistent with individual investing goals. Eligible shareholders are invited to subscribe for 1 new share for every 3.65 existing Healius shares held on Nov. 23, 2023. The retail offer is expected to open on Nov. 28, 2023, and close on Dec. 7, 2023.
An economic moat or sustainable competitive advantage allows a company to earn returns higher than the cost of capital. There are five sources of moat identified by Morningstar analysts and include cost advantage, intangible assets, network effects, switching costs and efficient scale.
Despite Healius having sizable market shares in Australian pathology and diagnostic imaging, its inability to set prices and weaker market position relative to Sonic Healthcare prevent it from digging an economic moat sourced from cost advantages. Revenue in pathology and imaging is earned via direct reimbursement from Medicare at fixed fee per service rates. Healius neither currently earns a return on invested capital above its cost of capital, nor do we expect it to in a typical year over our forecast period.
Fair value estimate
Our $3.00 fair value estimate for Healius factors in 5% group revenue growth in a typical year and a midcycle operating margin of 14%. Our estimates deliver earnings per share (“EPS”) growth of roughly 9% in a typical year. The pathology segment is the primary earnings driver.
We forecast a ten-year pathology revenue compound average growth rate (“CAGR”) of 4% and expect segment earnings before interest and taxes (“EBIT”) margins to expand to 14% by fiscal 2033 from 7% in second-half fiscal 2023 on operating leverage, improved mix, and productivity improvements.
Our 4% revenue CAGR is made up of 3% volume growth due to population factors and volume growth per capita and 1% average fee increases due to a mix shift to more complex tests such as veterinary and gene-testing. We do not factor in reimbursement pricing pressure in our base case.
Diagnostic imaging revenue is forecast to grow at an 8% CAGR over the 10 years to fiscal 2033 from a combination of organic volume growth and indexation of fees. We forecast EBIT margins to expand to 14% by fiscal 2033 from 10% in second-half fiscal 2023 through network optimization, customer digitization and exposure to higher-margin imaging modalities increasing.