Sigma Healthcare: Brokers Wary

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Following FY21 results for Sigma Healthcare brokers see an uncertain outlook for near-term earnings.

-Sigma Healthcare’s FY21 loss and weak cash flow
-Issues with software may continue to weigh on earnings
-Forward guidance withdrawn
-Potential leverage from new distribution assets
 

By Mark Woodruff

Following FY21 results for pharmaceutical manufacturer and distributor Sigma Healthcare ((SIG)), brokers see some uncertainty around short-term earnings.

The company operates through the Amcal, Guardian, PharmaSave, and Discount Drug Stores retail brands. Apart from pharmacies, products are also distributed via grocery channels and private label.

While rising by 1.3% year on year, revenue still fell -2.1% short of the consensus estimate. Meanwhile, like-for-like sales in Retail brands increased by 6.4%.

The concerns around near-term earnings held by both Credit Suisse and Citi largely stem from issues with an enterprise resource planning (ERP) software implementation, which has continued to disrupt sales. 

Despite the disruption, Macquarie points out the company only lost -1% market share of the Pharmacy Wholesale market in FY22.

Credit Suisse notes the pre-announced loss of -$7.2m was in line with expectation though considers cash flow was weak. Apart from ERP issues, Citi also attributes the loss to a change in software-as-a-service accounting methodology and a restructure of distribution centre assets.

Adding to general uncertainty, all explicit forward guidance was withdrawn under the direction of new CEO Vikesh Ramsunder. Credit Suisse feels the intent was to re-base expectations by walking away from prior medium-term earnings targets.

Impact of delayed ERP system implementation

Management noted that challenges in training staff remotely and implementing new processes have stalled progress for the ERP system implementation.

While the company expects the system to be fully stabilised by the end of April, with full optimisation by January 2023, Credit Suisse feels earnings will be impacted through FY23.

As a result, the broker retains its Neutral rating and doesn’t envisage significant upside for the share price in the short term.

The analyst points out poor service levels so far have led to lost sales from existing customers and stalled growth from new customers. This was particularly the case in Victoria where Chemist Warehouse, the company’s largest customer, was impacted.

Distribution Centres

Once ERP issues are stabilised and customer trust is recovered, Citi points out Sigma may then leverage the recently built distribution assets. Morningstar notes a function of the more automated distribution centres is a shift from variable labour costs to upfront capital investment.

Indeed, capital expenditure in FY23 is expected to be $40-45m, up from around $10m at the time of first half results.

Management indicated that the difference could be explained in large part by a $20m expansion of the Victorian distribution centre in Truganina to add capacity for the contract logistics division. A more normal level of around $5-$10m for capital expenditure is expected from FY24.

Macquarie points out return on invested capital (ROIC) is currently at a low point and believes capacity under-utilisation has contributed.

Outlook

While no explicit forward guidance was made, management alluded to a “return a profit” for FY23.

Meanwhile, Macquarie cautions the company is moving away from higher-margin, covid-related personal protective equipment products, and returning to a normalised product mix, which may negatively impact margins.

Overall, FNArena’s database has four broker ratings each with a Hold rating and a consensus target price of $0.51, which suggests -4.2% downside to the last share price.

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