Seeking Yield in The World of ZIRP? 1 Growth Company & 1 Value Company

This week we continue our series focusing on investments paying strong dividends while still remaining good investment propositions. The first is a dividend on a growth stock, Sonic Healthcare (SHL.ASX), while the second encompasses a value stock, GPT Group (GPT.ASX). ​

Sonic Healthcare (SHL.ASX)

Listed in 1987, Sonic is a business that has been a rather pleasant experience for long-standing shareholders, growing from a single laboratory to the third largest medical diagnostics business on the planet. Put simply, the business operates across three distinct lines, Pathology, Radiology and Primary Health Care. Sonic’s footprint now spans Australia/New Zealand, the US, Germany, the UK, Switzerland and Belgium. 

As could be expected, Covid-19 threw quite a tailwind behind the business’ revenues and profit margins with pathology in particular showing blockbuster returns. Sonic’s share price returning ~33% above its pre-Covid selloff peak. With that in mind, and with so much good news already baked in, it is a legitimate question to ask whether it is too late to buy. Before proceeding into the thesis, let's get the numbers out of the way. 
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FY21 revenue was up 28% to $8.8bn AUD, EBITDA was up 81% to $2.6bn and NPAT was up 149% to $1.3bn AUD. All this has been reflected with the share price up 24% on a 12-month basis with the business now tracking at 15.2x earnings. Seemingly fully priced but is there a case for investing still?

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Author: Sid Ruttala

For one, the business has tightened up their balance sheet; paying down debt to a level of 0.4x/EBITDA (compared to a historic rate of 2.4x) with additional liquidity facilities of $1.5bn giving them breathing space to undertake acquisitions to finance future growth. Indeed, the most recent acquisition was Canberra Imaging Group which we expect should have cost the company $100m at 9x earnings, maybe an indication of what is to come. We expect the company to continue undertaking acquisitions on an opportunistic basis, especially in the lucrative US and German markets. Given the company’s history, we do have faith in management's ability to ascertain synergies. Moreover the security is effectively a hedge against further deterioration in the Covid case count and the Delta Variant currently running amok in its biggest market, the US. We see a world in which humanity will have to contend with Covid at least for the foreseeable future, thus putting a permanent boost to the business’ pathology revenues.   
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While it is true that much of the current growth in pathology is baked in, we don’t think the market has yet priced in the capacity of this company to continue its growth over the long-run with its new found balance sheet capacity as a result of Covid. The fact that the company decided against a share buyback or raising its dividend in preference for paying down debt and reinvesting in the business is the prudent move (though perhaps not popular with the short-term punters). 

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​So, why does it make sense? 

While not necessarily a true yield play given where the dividend currently stands, we feel that Sonic is a great long-term dividend growth play. Sonic has a strong balance sheet that should allow for acquisitions across the massive North American and European markets as well as grow earnings organically. The market is expecting a normalised organic growth rate in the mid-single digits (taking out Covid). We do not think this is the case. Rather, the continued evolution of the virus (as we have already seen with the Delta variant) should see longer-term support of their revenue stream even with the increased vaccination rates in their markets. 

Moreover, we would also like to reiterate their position as somewhat of a hedge against Covid.

Red Flags & Risks:  The biggest risk for the investor remains the company’s valuation at 50x earnings. Further vaccination uptake outside of Australia should also see shorter term deterioration in the overall numbers. Nevertheless, we do feel that Sonic’s ability to be acquisitive and their strong balance sheet should cushion any shorter-term gyrations. 

Dividend Yield: 2.15% with expectations of 7-8% growth on an annualised basis.

GPT Group (GPT.ASX)

​We’re sure that many of you would be familiar with this particular REIT given their ownership of some iconic pieces of real estate. This includes Melbourne Central, Australia Square and Governor Philip Tower. Since spinning-off from Lendlease the business has continued to grow and has become one of the largest owners of prime and A-Grade real estate . 

GPT’s segment breakdown is as follows: Retail Property (40%), Office (40%) with the balance being a combination of industrial and logistics assets. As you can imagine, GPT was at the front-lines when it came to the Covid-related sell off, the security losing close to 50% from peak to trough and never quite recovering. The market remains pessimistic when it comes to retail and commercial office assets. This begs the question, why does this particular business look interesting to us? 

Before we get to the thesis, the numbers. Funds under operation was up 24% on the previous comparable period (pcp), portfolio occupancy came in at 95.6%, NPAT was $760m AUD (compared to a loss of $470m AUD in FY 2020), a WALE of 4.8 years and, more importantly, NTA of $5.86 AUD per share. For the investors out there, the last part is perhaps the most important part (in my view). Even if we accept the headwinds facing the retail segment (and let’s assume the market is right), we feel that this has been priced in by now. Returning to Investing 101 to explain this a little better, the price of a security is made up of two components; the first is the security’s underlying value and the second the market's expectation of future growth. At the current share price of $4.80 AUD, it is safe to assume that the market sees a rather pessimistic future for the business. We don’t believe this to be the case. 

Firstly, the business’ exposure to commercial office space is within the premium segment which remains much more amenable to flexible working space and recent updates suggest that this is the case with leasing and enquiry inspections strong. Secondly, the company seems to have a coherent strategy to navigate the headwinds facing the retail segment and adapting their exposures with logistics, office and industrials making up the majority of their development pipeline.

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​So, why does it make sense? 

We feel that GPT sits in a reasonable position to recover back to at least pre-pandemic levels. Their development pipeline, if executed correctly, should deliver substantial growth to the pipeline. At current share price, we feel that it remains a reasonable buy. 

Red Flags & Risks:  Given that the majority of GPT’s business remains within prime commercial real estate in Sydney and Melbourne, the share price will remain acutely exposed to further lockdowns and covid related events. In addition, much will be contingent on delivering on flexible workplace strategies and their ability to value add across retail assets. We feel that the market isn’t completely wrong in that structural changes are taking place across the segments GPT operates. Management appears to be aware of this and are looking to adapt; nothing the company shouldn’t be able to handle providing they execute. 

Dividend Yield: 5.3% ​

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Disclaimer: GPT is currently held in some TAMIM individually managed accounts.