Time to heal

1H23 RESULT

Need To Know

• Result largely pre-announced, no specific outlook provided
• New CFO appointment
• No dividend declared, focus on debt reduction

The 1H23 focus has been on cost reduction to respond to the market conditions in Pathology, as Covid testing volumes dropped 88% over the period. Base pathology revenue grew 1% and imaging revenue grew 10%, outperforming the market and underpinned by investment in digital and contract wins. HLS also unveiled its new CFO, Paul Anderson, who was previously the CEO at Network Ten.

PCR testing demand dropped nearly ~$500m in the period from historic highs. Consequently, margins declined, and HLS has now removed all costs other than equipment and has adjusted the laboratory staffing to align with current volumes, with FTE @~6,000 v ~6,500 in 1H20. 

Gearing is within covenants, but above target. Net debt rose to $551m, with gearing at 2.98x, slightly below the <3.5x covenant, and interest cover of 10.5x above the >3.0x covenant. Drawn debt will reduce with receipt of funds from sale of Day Hospitals (~$127m before earn-out). Due to the higher debt, HLS did not declare a dividend.

New cost base reset from a significant cost out in laboratory labour resets has seen corporate costs already reduce to <$20m pa. From a 1H20 base, labour costs have only increased 2%pa to $412m, whilst total costs have increased just 1%pa to $766m driven as well by procurement savings on consumables. 

2H23 recovery. HLS expects a ‘materially stronger’ 2H23, however we note there are several near-term headwinds, including GP shortages impacting referrals, lower MBS reimbursement rates and an increase in competition. For HLS to recover its margins to more normalised levels, it would need to unwind ~$30m of costs in 2H.

Recovering YTD trading. In late Jan/early Feb, HLS noted daily revenues returning to pre-Christmas levels. BAU testing continues to recover, and HLS expects between 1-2k Covid tests per working day.

Investment View

With the cycling of Covid testing volumes coming close to its end, the company can return its focus to the growth of the base business. Competition for pathology remains intense, with newer entrants such as 4cyte growing sites aggressively. Medicare data is not yet indicating clear recovery trends, which we would like to see before viewing the stock more favourably. 

Margin improvement traditionally comes from closing pathology centres (with none being closed post-covid so far), which will impact revenue growth potential. The potential for M&A activity however remains.  

We believe the worst is likely over and the downgrade cycle is reaching its end although note that there remain risks to margin recovery. On an FY25 PER multiple of ~17x, the stock is in-line with its longer-term average multiple, although the stock will likely continue to be volatile. We retain our Hold recommendation.

Figure 1: Solid imaging result, still cycling Covid volumes

Figure 2: BAU margins to improve post cost restructures through 1H23