Sonic Healthcare (ASX: SHL) reaffirmed fiscal 2026 EBITDA guidance of 8% growth at the midpoint in constant currency terms, with solid organic sales growth of 5% year to date. Management also guides to modestly lower fiscal 2026 depreciation and interest expense. Shares reacted positively, up 6%.

Why it matters: We think the market is encouraged by Sonic’s solid start to the year, with fiscal 2026 EBITDA guidance reaffirmed and a stronger implied bottom line. We increase our fiscal 2026 EPS forecast by 2% on lower rental expenses, but our long-term estimates are broadly unchanged.

The bottom line: We maintain our $33 fair value estimate for narrow-moat Sonic Healthcare. Shares are undervalued as we remain optimistic about Sonic’s profitability improving. We keep our forecast fiscal 2035 EBITDA margin of 21% compared with 18% in fiscal 2025.

  • We forecast fiscal 2026 EBITDA margins to compress by 50 basis points due to recent margin-dilutive acquisitions. However, Sonic stands to benefit in the short term from cost synergies, including headcount reductions, leveraging IT investment, and lower procurement costs on greater scale.
  • Long-term, we expect margin expansion on increased operating leverage from higher volumes and improved labor productivity as digitization and newer artificial intelligence tools expedite diagnoses. Inflation of the main costs, labor and rent, is also easing.

Big picture: We expect solid revenue growth on higher pricing, supported by additional government funding, and favorable mix shift benefits to more complex testing. We forecast Sonic’s Australian pathology and imaging revenue to grow at a 5% and 7% compound annual growth rate, respectively, over our 10-year forecast period.

  • Sonic has a progressive dividend policy and a strong balance sheet with net debt/EBITDA at 2.0 at June 2025. Sonic is comfortably positioned to make further acquisitions and meet our long-term 75% dividend payout forecast, implying dividends growing at a 10-year CAGR of 7%.

Sonic Healthcare’s long-term outlook remains strong

Sonic Healthcare’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volume is an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders.

Sonic’s organic volume growth in its core laboratories segment has typically ranged between 3% and 4%, and we forecast a similar rate over our 10-year forecast period. The volume growth is underpinned by population growth, aging demographics in developed markets, higher incidence of diseases, and wider adoption of preventative 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.

Laboratory medicine, or pathology, has a high fixed cost of operation and thus benefits from volume growth to drive lower cost-per-test outcomes. Sonic benefits from cost efficiencies by maximizing throughput through its network of laboratories and collection centers. Higher testing volume results in a lower cost per test as labor, equipment, leases, transportation, and overhead costs are all leveraged.

The company has historically been highly acquisitive, particularly overseas. Synergies from procurement and integrating IT are relatively easy to capture, and given its cost advantage, Sonic is well placed to boost its organic revenue with bolt-on acquisitions. The US and Germany are singled out as the most likely sources of acquisitions, given their fragmented markets. In addition to acquisitions, Sonic is sourcing more volume to put through its laboratories from joint ventures with hospitals in the US whose in-house laboratories are typically subscale and would operate at higher costs. Operating capacity within Sonic’s existing laboratories is highly flexible by adjusting operating hours.

Bull say

  • Sonic has a leading market position in most of its geographies and as a result benefits from a cost advantage derived from scale.
  • On top of the base level of covid-19 testing that is likely to continue, demographic factors and the focus on value-based healthcare support global volume growth in preventative diagnostics.
  • Advances in technology and personalized medicine are increasing the number of complex and gene-based tests available to patients, which are typically higher-margin.

Bears say

  • Elevated covid-19 testing is not able to be maintained and acquisitive growth is becoming more expensive to achieve.
  • Regulatory reimbursement pressure could increase in the US if many hospital-based labs fail to comply with the data collection and reporting requirements of the Protecting Access to Medicare Act.
  • Typical ROICs of roughly 9% are only slightly above the 7% WACC.

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