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Sigma Pharma’s Expansion Strategy On Track

Australia | Sep 12 2016

Sigma Pharmaceuticals is expanding its reach into hospital pharmacy while maintaining a stable base business. Brokers welcome the increased diversity.

-Non-PBS sales at 44% and an increasingly higher proportion of Sigma's business
-Capital releases may now be limited in scope
-Little visibility on supplier rebates and merchandising income


By Eva Brocklehurst

With its first half results, Sigma Pharmaceuticals ((SIP)) is seen spearheading its entry into the hospital pharmacy market amid expectations it will annualise $200m in sales by the end of the year.

The company ticked all the right boxes, Morgan Stanley asserts. Revenue growth was strong with like-for-like pharmacy brand sales up 7.2%. The company's confidence in its outlook is reflected in guidance being upgraded to 10% EBIT (earnings before interest and tax) growth for FY17 while estimates of over 5% growth are retained for FY18.

Yet the results produced a spate of changes to recommendations. UBS and Credit Suisse upgraded to Buy and Outperform respectively, while Citi downgraded to Sell. In sum, FNArena's database now has two Buy, one Hold and one Sell. The consensus target is $1.30 which suggests 7.5% downside to the last share price. Targets range from $1.15 (Morgan Stanley) to $1.40 (UBS).

UBS considers the results are a sign the inflection point has arrived for Sigma, in terms of new growth opportunities, at the same time the base business is steady and reliable. The broker acknowledges it underestimated the turnaround in underlying margins and, post the result, increases estimates for FY17 and FY18 by 7.3% and 9.7% respectively.

Non-PBS (Pharmaceutical Benefits Scheme) sales are now 44% and the company hopes to reach a 50:50 mix. PBS growth was reported as flat, with over-the-counter sales up 5%. Direct sales to China were not disclosed but the company suggests these are ahead of expectations, albeit modest.

The reported EBIT margin was diluted because of sales of the new drug Sofusbovir (hepatitis C), given the drug is high price but low margin. Inventory did build, affected by an additional $30-40m for the supply of Sofusbovir. UBS detects that the company is spending more time on expanding buying programs to extract higher rebates while at the same time investing in infrastructure.

The broker agrees that in terms of pharmacy wholesalers, the company has had lower exposure to the higher top line growth channels in the market, but observes an intention to grow the exposure to general retail. UBS notes the company has, nonetheless, also demonstrated an ability to manage its earnings mix and achieve a small margin uplift. The investment in hospital pharmacy is expected to provide greater exposure to an attractive growth market.

Citi envisages the outlook somewhat differently. Given poor prospects for PBS revenue and the end of working capital benefits from a pull-back in customer credit terms, the company is investing to maintain its margins and diversify its revenue sources. Sigma has been successful in pulling extended credit terms and reducing working capital and this has meant capital has been released to fund its buy-back and other initiatives. There is now limited scope in this regard, Citi believes.

The broker expects the company to outperform on guidance and upgrades earnings per share estimates by 4% and 6% for FY17 and FY18 respectively. Citi considers the stock now overvalued in a challenging environment for its main business, along with the risks that come with significant capital expenditure on investments.

Rising “other revenues”, which include supplier rebates and merchandising income, are suspected as accounting for a large proportion of profits but the broker finds little visibility in this area and remains wary of the long-term sustainability as a result.

PBS revenue may remain under pressure but higher growth in non-PBS revenue as well as the winding back of trade discounts should sustain gross profit growth, in Credit Suisse's view. Moreover, incremental wholesale opportunities such as hospital pharmacy and distribution centre optimisation should underpin the long-term. The broker also notes an un-geared balance sheet and the potential to pursue suitable acquisition opportunities.

Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, also upgrades, to Neutral from Sell, with a target of $1.30. The broker's prior Sell rating was based primarily on a lack of valuation support as well as long-dated regulatory risk. Given the upgrades to FY17 and FY18 estimates, this situation has improved and, while long-dated regulatory risk remains, the broker does not believe it to be a near-term catalyst

Goldman Sachs believes the long-dated agreement with market leading Chemist Warehouse provides an ability to grow market share and underpins margins. There is also scope to leverage the balance sheet with further acquisitions share buy-backs and internal projects with an attractive pay-back time frame.

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