Small Caps | Apr 26 2018
Soft retail conditions continue to cast a cloud over Australian Pharmaceutical Industries and brokers expect growth in FY18 will be a challenge.
-Weak consumer sentiment challenges earnings
-Competitive pressure causes price deflation in retail
-Another manufacturer chooses to bypass wholesale
By Eva Brocklehurst
Australian Pharmaceutical Industries ((API)) reported subdued first half results, encountering difficult trading conditions across both its retail and wholesale divisions. Underlying operating earnings (EBIT) declined by -8.3% and net profit fell by -14%.
Early signs of growth that appeared in FY17 were short-lived, Morgan Stanley observes, as distribution and retail headwinds intensified. Wholesale distribution revenue was flat while Priceline pharmacy comparable store sales declined -1.7%.
The broker asserts that despite the company claiming pharmacy distribution is on track, weak consumer sentiment has affected earnings and led to a subdued outlook. Forecasts are downgraded and Morgan Stanley maintains an Underweight rating and $1.43 target.
Growth in the store network also appears challenged, given the company's suggestion that rental demands are unrealistic. Amid concerns regarding the rolling out of the network and a soft retail environment, the broker believes cash conversion will remain low.
Retail
Bell Potter notes, within retailing, competitive pressures have caused price deflation among key product lines in health and beauty. Consequently, retail revenue declined by -0.7% and gross profit by -3.4%. The broker acknowledges second half cash flows are traditionally stronger for the company and this should be the case again in FY18.
Guidance is for the underlying result to be marginally above FY17, provided trading conditions do not deteriorate further. Still, Bell Potter is not encouraged by retail price deflation and expects it to persist for the rest of the year. As a result underlying earnings estimates are downgraded by -3.9%. FY19 estimates are downgraded by -4.9% and Bell Potter retains a Hold rating and $1.43 target.
While the company expects marginal growth, pointing to underlying sales growth of 9.8%, Morgan Stanley suggests the bigger issue is low cash conversion. The broker agrees, to meet guidance, a recovery in retail trading is required.
Pharmaceutical Benefits Scheme
PBS revenue is expected to remain under pressure as some manufacturers choose to bypass wholesale distributors and go direct to pharmacies. The company's move to diversify away from PBS revenue stream by converting independent pharmacies to the Priceline model could increase operating leverage, Credit Suisse suspects.
This leverage should come via higher distribution volumes, supply rebates and franchise service fees. Nevertheless, the broker is cautious about the retail strategy because current market conditions suggest comparable store sales are slowing while competition is increasing. Credit Suisse has a Neutral rating and $1.50 target.
Continued price discounting of prescription pharmaceuticals has eroded the earnings capacity and, as the margin claw-back from pharmacy clients is now complete, Bell Potter suggests earnings growth will be difficult in the future.
AstraZeneca announced a decision to bypass wholesalers for the distribution of a portion of its products to pharmacy. The broker notes this is the third supplier to take this path after Pfizer in 2012 and Amgen in 2017. API estimates that, over a full year, the revenue impact wholesalers will be around $100m, of which it will absorb around one third.
API has indicated it is considering the future of wholesale pharmacy, likely to be now ex-growth, including how to drive further returns from the assets.
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