Australia | Jun 02 2011
– Five of seven ratings for Sigma Pharmaceutical in FNArena database are Sells
– Morgan Stanley goes against consensus and upgrades to Overweight
– Upgrade supported by greater confidence in earnings estimates
– Industry conditions also improving
By Chris Shaw
With RBS Australia ceasing coverage last month seven brokers in the FNArena database cover Sigma Pharmaceuticals ((SIP)) and none of them have favourable views, the stock scoring two Holds and five Sell recommendations.
But Morgan Stanley has gone against the trend, upgrading to an Overweight rating on Sigma within a Cautious view on the Australian Pharmaceutical Distribution and Retailers sector.
According to Morgan Stanley, Sigma is already starting to enjoy an improvement in trade terms, which is helping offset lost revenues. This improvement is expected to continue and is estimated to potentially lift return on invested capital (ROIC) by around 500-basis points by FY13. Reining in the current level of receivables should also help lift ROIC in Morgan Stanley's view.
As well, Sigma is now operating on lower working capital levels and Morgan Stanley expects this will result in ROIC being greater than the weighted average cost of capital (WACC) over the next three years. Sigma itself is guiding for three year average ROIC of more than 11%, which compares to the 7.3% achieved in FY11.
This playing out would be a key catalyst in Sigma shares closing the current 30% discount to net tangible asset backing in Morgan Stanley's view. This implies some value in Sigma at current levels, especially given industry growth figures gives Morgan Stanley analysts greater confidence in their earnings forecasts.
Morgan Stanley is forecasting earnings per share (EPS) of 3c for both FY12 and FY13. This compares to consensus estimates according to the FNArena database of 2.4c for FY12 and 2.6c for FY13.
What adds to Morgan Stanley's confidence is feedback from recent industry meetings, with the Pharmacy Guild indicating Sigma's new trading terms are sticking. Growth for the industry also looks constructive, the Pharmacy Guild expecting low single-digit top-line growth and improved pharmacy profits via increased use of generics.
At current levels Morgan Stanley estimates Sigma is trading on a FY12 earnings multiple of 13.6 times, while expectations of improvement in ROIC should support a higher multiple. Morgan Stanley's 12-18 month price target of $0.49 implies an earnings multiple of around 17 times is appropriate.
Aside from earnings, Morgan Stanley notes there is potential valuation upside from a possible Pharmacy Alliance Group tender win by Sigma, which would add a further 7c to valuation.
As an indication of how Morgan Stanley's view is the opposite to the rest of the market, the broker's price target of $0.49 compares to a consensus target according to the FNArena database of $0.34. The range of targets is wide, with Deutsche Bank ascribing a target of $0.50 with a Hold rating, compared to Citi with a Sell recommendation and a target of just $0.23.
Shares in Sigma today are slightly higher, trading up 0.5c at 39c as at 11.20am. Over the past year Sigma has traded in a range of $0.305 to $0.55, the current share price implying downside of around 12% to the consensus target in the FNArena database.
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