Australia | Mar 26 2012
– Sigma result showed improved metrics
– Further improvements expected in coming months
– Tough industry backdrop tempers views
– Neutral and Sell ratings continue to dominate
By Chris Shaw
Sigma Pharmaceuticals ((SIP)) reported full year net profit of around $50 million for FY12, the result showing improvement in terms of market share gains, margin improvement, cost control and strong cash conversion.
This improvement should continue through FY13 and into FY14 according to BA Merrill Lynch, but price adjustments such as for Lipitor on December 1, 2013 will impact on the group's financials. In the view of JP Morgan, Sigma's result confirms the company is now better placed to deal with the effects of Pharmaceutical Benefits Scheme (PBS) reform.
The problem is the industry backdrop will make growth difficult given flattening PBS growth and increasing financial pressures. These pressures have big pharma groups waiting to acquire any bankrupt pharmacy licences that become available. Thus ongoing industry consolidation will create ongoing pressures on distributor margins according to JP Morgan.
Financially Sigma is in a position where it can consider growth via acquisition to offset the impact of worsening industry dynamics as the balance sheet shows net cash. An issue for BA-ML is finding a suitable acquisition to generate a return on investment of around 15% given the industry dynamics in place.
If acquisitions are not made Deutsche Bank sees scope for ongoing capital management initiatives, especially given the view returns and operating cash flows will continue to improve. This supports a positive view on the stock in Deutsche's view, so post the result the broker retains a Buy rating.
This is the only positive view on Sigma among brokers in the FNArena database, which shows three Neutral recommendations and three Sell ratings. Consensus price target stands at $0.61, up slightly from before the full year result.
Citi is one broker with a Sell rating, arguing FY13 will be challenging as the majority of PBS generics will be subject to an average price cut of 28.7%. While Sigma plans to reduce rebates to help counter this, Citi expects pharmacists will push against any such reductions.
While guidance from Sigma for FY13 was not specific and implies little more than further improvement in return on capital invested and the maintenance of a high dividend, this is not a stretch in Citi's view. Factoring in its forecasts leaves Citi expecting a negative total return from Sigma, which suggests little value at current levels.
UBS agrees with Citi's Sell rating, arguing the adverse industry structure leaves little room for earnings growth going forward. Valuation is also not favourable in UBS's view, as the broker's numbers imply a 14 times one-year forward multiple and this is a 15% premium to market earnings multiples.
BA-ML's estimated valuation for Sigma is $0.66 per share and on this basis the broker retains a Neutral rating, though it sees risk for Sigma if others follow the lead of Pfizer and attempt to market products directly.
Outside of the FNArena database, Goldman Sachs has downgrade Sigma to a Neutral rating and removed the stock from its Australia/NZ Buy list. This reflects both recent share price gains and the view the stock is fair value at current levels given the industry risks going forward.
Moelis also rates the stock as a Hold, taking the view a forecast FY13 earnings multiple of 13.7 times, which is a 21% premium to the Small Industrials index, as not compelling given the industry's structural issues that include ongoing government funding pressures.
While Sigma's yield is attractive and the balance sheet is in good shape, until the cash available is deployed for a suitable purpose the stock looks appropriately priced in the view of Moelis.
Shares in Sigma have moved within a trading range over the past year of $0.305 to $0.755. The current share price implies downside of about 4% relative to the consensus price target in the FNArena database.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
