Australia | Sep 15 2009
By Chris Shaw
In what was a well-flagged result Sigma Pharmaceuticals ((SIP)) delivered a reported interim profit of $32.2 million, a result generating broker comments such as “lacklustre” and “weak at the operating level”.
In terms of the company’s various divisions the wholesale operations delivered a solid performance in the period, but the generics division is what has most brokers concerned as industry-wide discounting continues to pressure margins. Southern Cross Equities points out the group’s consumer brands are poorly positioned and this is also hurting earnings.
But Southern Cross takes a different view to most of the market in suggesting these issues are legacy issues and management is now addressing them. In its opinion this means the company should be able to continue building shareholder value, particularly as the recent equity issue to raise $297 million has improved the balance sheet with gearing falling to around 35%.
Looking forward, Credit Suisse notes the result, plus the fact management has retained full year guidance of modest growth in earnings, means an earnings split of something in the order of 64% in the second half is required. CS views this as a stretch, not least because the guidance contained a number of caveats such as no changes in the regulatory environment, no changes in consumer or customer demand and new product launches meet timing and budget expectations.
Southern Cross is more optimistic, suggesting there are signs of a stabilising in the level of discounting in the generic sector, so the fact the company has maintained its market share of 35-40% means it is well placed to benefit from any improvement in conditions. The other point of note for generics is a number of new, big ticket drugs become eligible in coming years, something the broker sees as offering some upside potential for the company going forward.
Southern Cross also takes the view it was consumer issues that contributed more to the result than the generics operations as the issues in the latter were already well known, so signs these consumer brands are now doing better and market share is improving is a positive for the second half result.
JP Morgan is less positive on the generics outlook however, suggesting competition continues to erode margins at the same time as delays to new product launches are also having a negative impact. The other issue in the broker’s view is while increased generic substitution at the pharmacy level in theory offers some upside to the company, in practice most of the benefits to date have been passed back to the pharmacists. JP Morgan expects this trend will continue in coming years, so limiting the earnings potential of the division.
Bank of America Merrill Lynch expressed similar concerns with respect to the margin outlook in generics given competition remains fierce, while UBS suggests structural issues in the sector will limit the potential for improved performance in coming periods.
Elsewhere in the company performance was satisfactory in JP Morgan’s view given tough conditions, with the healthcare division delivering better than expected earnings on in-line revenues, while the pharmacy wholesaling division also achieved better than expected earnings and offers some potential in its view if the company can leverage its presence into better performance in the pharmaceutical division.
Again, Southern Cross suggests such improvement is possible as it notes while pharmaceuticals earnings fell 11%, margins dropped only 40-basis points. This implies manufacturing efficiencies are being generated. In its view this implies a base for recovery once the value of the consumer business is rebuilt.
The other source of potential upside to earnings comes via the recent equity issue as the company now has no re-financing risk until 2011, leaving the door open for potential bolt-on acquisitions, notes Southern Cross. Macquarie also commented on the potential for acquisitions, seeing it as a possible offset to margin pressure in the wholesaling division in particular.
Macquarie wasn’t getting carried away with upside potential however, retaining its Neutral rating given the margin issue in generics and the potential for structural changes related to the PBS or Pharmaceutical Benefits Scheme. Overall the FNArena database shows a total of six Hold ratings and four Sells, with no changes to ratings post the interim result. This means Southern Cross is the odd one out compared to the database in retaining its Buy recommendation post the result. (Note: Southern Cross is not a member of the usual sources that are monitored daily by FNArena).
While ratings were unchanged there were some adjustments to earnings estimates, Southern Cross lowering its earnings per share (EPS) numbers by 11% and 10% in FY10 and FY11 to 9.1c and 10.3c respectively, while Macquarie took 5% off its FY10 forecast but lifted its FY11 estimate slightly. Credit Suisse cut its current year number by around 3% but made only a minor change in FY11 and is forecasting EPS of 9.1c and 9.2c, while the FNArena database shows consensus forecasts for the two years of 9.6c and 10.2c respectively.
Sigma’s financial year ends in January.
The average price target according to the database stands at $1.06, up slightly from $1.05 prior to the result and again Southern Cross provides a significantly different view, retaining its target of $1.60 given it is the mid-point of its valuation range for the shares of $1.45 to $1.75.
Shares in Sigma today are slightly higher and as at 11.20am the stock was up 1c at $1.07, which compares to a trading range over the past 12 months of $0.865 to $1.47.