Why the market may be wrong about Healius shares

Healius (ASX: HLS), Australia's number two pathology services operator, has seen a decline in the past few years. Its share price now sits about three-quarters below its peak.

We believe that the company is on a turnaround path.

While we believe that it may be unlikely that the company will revisit its historical highs, what investors may get is a situation where reward could outweigh risk.

A solid foundation

Pathology, the lab testing of blood and tissue samples, is critical to most medical decisions. An ageing population only increases demand for these services. On paper, Healius should be a consistently growing and stable business.

But it hasn't been the case. Below-normal GP visitations (and therefore fewer referred pathology tests) have weighed on the industry. A shortage of doctors, inflation pushing up consultation fees, and less bulk-billing have all made patients think twice about booking an appointment.

For pathology operators, wage inflation has also eaten into margins. Due also to underinvestment and already high debt, Healius was hit harder than its peers. Margins fell to near zero.

The turnaround plan

Healius now has a two-year plan to lift operating margins back to the high single digits, similar to its history and the 8-11% margins peers enjoy.

The recovery is being driven by:

• Volume growth: Pathology test volumes are rising 5-6%, back near historical levels
• Revenue boost: Government indexation on certain lab tests is providing a lift
• Higher-margin focus: Expanding into specialist channels
• Cost discipline: Wage pressures are easing, and costs are growing more slowly.

Immediate savings are also on the table. Cutting A$15 million to A$20 million in corporate and other costs could potentially add roughly 1.5% to margins. Importantly, the company has plenty of spare lab capacity, allowing growth without major new spending.

Market is playing it safe

Currently, the market is assuming long-term margins of around 5%. On that basis, Healius is fairly valued at about 15 times operating earnings. But if margins land closer to 8% or higher, the share price could re-rate.

The company also has a strong balance sheet, is in a net cash position, and has the capacity to pay dividends, which is something investors may be overlooking.

The case to invest

Healius has faced significant challenges. Expectations are low, but in our view, the fundamentals of its business remain sound. If the turnaround gains traction, the upside could potentially be meaningful, and in the meantime, investors can be confident in owning a business that has an essential role in Australia's healthcare system.

This material is for informational purposes only. It is not intended to, and does not constitute financial advice, fund management services, an offer of financial products or to enter into any contract or investment agreement in respect of any product offered by Lazard Asset Management and shall not be considered as an offer or solicitation with respect to any product, security, or service in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or unauthorised or otherwise restricted or prohibited.

Certain information referenced herein contains "forward-looking statements", identified by the use of words such as "may," "will," "should," "expect," "anticipate," "target," or "believe," or the negatives thereof or comparable terminology. Due to uncertainties regarding the future, actual events may differ materially from those contemplated in such forward-looking statements.

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