Australia | Oct 22 2009
By Chris Shaw
Full year earnings from Australian Pharmaceutical Industries ((API)) were better than many in the market had expected, with net profit for FY09 increasing 22% to $18.6 million on sales up 9.6% from last year at $3,550 million.
In the view of Credit Suisse, the result contained both positives and negatives, the good points including solid pharmacy sales growth and solid comparable same store sales growth of 5.4% from the Priceline retail operations. On the minus side the broker notes gross margins fell by around 80 basis points and cash flow from operations declined by 62%.
As well, the quality of the result was somewhat disappointing in the broker’s view as profit was boosted by a $6.2 million gain on an asset sale. UBS touched on this element as well in its review of the result, noting falls in interest rates over the course of the year allowed the company to deliver trading net profit growth for the period that it wouldn’t have otherwise been able to achieve.
The weak cash flows generated in the period didn’t help with API’s biggest issue a high level of gearing on its balance sheet. This has caused management to attempt to address this by a two-stage capital raising aimed at bringing in $150 million. The raising will include a $38 million placement at 65c per share, which will be followed by a 2-for-3 rights issue. Credit Suisse estimates the issue will be around 30% dilutive to earnings per share and so it has adjusted its numbers accordingly.
On the plus side, CS notes by removing gearing as an issue it will free up management to focus on delivering operational improvements. Southern Cross Equities is also positive on the capital raising as it means gearing should fall to around 25% from 70% previously while interest cover improves to around four times in FY10 from two times previously, which implies a stronger financial position for the company.
Southern Cross viewed margin performance somewhat differently to Credit Suisse and estimates the company was able to lift retail margins by around 30 basis points, an outcome it suggests helped grow earnings from the Priceline stores despite relatively few stores being opened in the period. Southern Cross suggests this is a good sign entering FY10 as the momentum on display should continue through the coming year when there will be an increase in the number of new stores opened.
This outlook supports guidance from management for around 10% growth in earnings in FY10 pre the effect of the capital raising, which flows through to Southern Cross ascribing a value range for the shares of $1.44-$1.74 based on its earnings per share (EPS) estimates of 6.2c in FY10 and 7.5c in FY11. This compares to Credit Suisse’s EPS estimates of 5.4c and 5.8c respectively and UBS at 5c and 6c, while the FNArena database shows consensus EPS forecasts of 6.0c and 6.3c for FY10 and FY11.
Based on its valuation range, Southern Cross Equities has set its price target for the stock at $1.60, which puts it well above the rest of the market as the FNArena database shows and average price target of $0.65, up from $0.59 prior to the result. Credit Suisse lifted its target post the result to $0.65 from $0.50, while UBS’s price target moved to $0.62 from $0.61.
Given the disparity in targets it is not surprising ratings are also different, with the FNArena database showing two Sells and two Holds against the Buy rating of Southern Cross Equities. (Southern Cross is not part of the usual FNArena coverage). Deutsche Bank is one to rate the stock a Hold, noting while the result showed signs of an operational turnaround, this is already in the share price following recent gains.
Credit Suisse also sees little value and retains its Underperform rating as on its numbers the company is trading on around 12 times earnings in FY10 , this despite expected negative earnings per share growth given the increase in shares stemming from the capital raising. UBS also retains its Sell rating as it suggests the level of sales growth to working capital is a concern, while the potential for regulatory changes in the sector means there is some downside risk to earnings.
Shares in Australian Pharmaceutical are currently in a trading halt as the first part of the capital raising is completed, with the last trade pre the profit result being at $1.055. This compares to a trading range over the past year of $0.35 to $1.10.