Australia | Mar 26 2008
By Chris Shaw
Recent falls in the market generally and in certain stocks in particular are seemingly making it easier to find value but there remain a number of apparent value traps in the Australian market and following disappointing earnings guidance for FY09 Sigma Pharmaceuticals ((SIP)) is being regarded by more than one broker as an example of one of them.
The company has delivered FY08 earnings as expected at $90.2 million pre-significant items but advised earnings in FY09 would be impacted by significantly higher interest charges than previously expected. Guidance from management is for a result of $83-$88 million, which JP Morgan notes compares to pre-guidance consensus of $98 million, meaning cuts to estimates are to be expected across the market.
These have begun to flow through with the broker itself lowering its FY09 forecast by 15% to $88 million and cutting its forecasts in future years by 12%, though it cautions these cuts may not be enough as there remains scope for profits in FY10 to fall below those of FY09 if the impact on the generic drug division of upcoming price cuts of 25% are larger than management currently expects.
ABN Amro was also disappointed in the FY09 guidance and has cut its earnings estimates by 10%, while Macquarie and Deutsche Bank have also cut their forecasts in accordance with guidance. UBS has gone against the trend somewhat and made a minor increase to its earnings per share (EPS) estimate for FY09, though the broker points out this is largely to account for the impact of a recent share buyback.
For FY09 and FY10 EPS estimates are in the order of 10 -13c and 11-15c respectively, Thomson One Analytics noting median EPS forecasts are 11c in FY09 and 13c in FY10. But as JP Morgan points out earnings risk remains to the downside from two areas, the generic price cuts and the group’s attempt to create a bundled offering.
UBS notes management takes the view the generic price cuts should be met with volume increases as pharmacists can be expected to increase their buying of the generic drugs as margins for them will remain more attractive and while this appears logical the broker points out it doesn’t mean that is what will in fact happen.
JP Morgan also suggests management is being somewhat optimistic in assuming earnings in the generic division won’t be impacted by the price cuts as competition in the sector remains strong. This means there remains risk margins could in fact fall significantly but still remain higher than is the case in overseas markets, which suggests the level of competition is not going to ease anytime soon.
The broker’s other issue is the company has not as of yet had great success with its Embrace compliance program, which it suggests raises questions as to whether or not it will be possible to successfully bundle generics, wholesale and OTC (over the counter) options into one company and create a competitive advantage by doing so.
If this strategy doesn’t prove successful the broker notes the best placed will be those companies that are the lowest cost providers in each area, which would put the company at a disadvantage in the generics market in particular.
Highlighting the apparent value trap in the stock given the current uncertain outlook for the generics operations, Citi points out the stock price is now at levels that would ordinarily trigger a Buy rating but this has been over-ridden and a Hold recommendation maintained. The broker suggests further evidence of strong cash flows associated with the Arrow business need to become evident before it would consider upgrading its rating.
JP Morgan takes a similar view view and notes while the stock looks cheap given it is trading on a 12-month forward P/E of 12.6x the lack of any positive earnings catalyst means there is no reason to be in the stock given the downside earnings risk.
ABN Amro agrees and estimates it will be FY10 at the earliest before the company will see any earnings benefit from its strategy, this assuming all goes well in the meantime. As a result while it sees the shares as within value territory it equally sees no need for investors to hurry to get set in the stock. Credit Suisse also takes the view any turnaround will take some time to flow through and the broker also sees a need for management to re-establish credibility in the market, a process that usually takes a few results to achieve. On the plus side in this regard Citi notes the new CFO provided a much clearer update than had previously been the case with the company.
This lukewarm attitude towards an apparent value situation plays out in the ratings as the FNArena database shows seven Neutral recommendations compared to two Sells and UBS as the lone Buy. The average price target is $1.56, down slightly from prior to the cut in guidance and comfortably below the median target according to Thomson One of $1.72.
Shares in Sigma today are slightly weaker despite a stronger overall market and as at 1.15pm were down 1.5c at $1.255. The stock has traded over a range of $1.225 to $2.63 over the past 12 months.