24 January 2012
Paul Cuddy, Bennelong Australian Equity Partners' CEO, shares his views on Sigma Healthcare and explains why they hold the stock in the Bennelong ex-20 Australian Equities Fund.
Sigma Healthcare (Sigma) is predominantly a wholesale distribution business with a retail division. Sigma Retail provides retail services to pharmacies through the Amcal, Guardian and Amcal Max brands. Sigma Wholesale is one of three full line pharmaceutical distributors in Australia and offers daily delivery services to over 3,800 retail pharmacies from its 13 distribution centres located throughout Australia.Sigma recently sold its pharmaceuticals division to Aspen for $900m, with the proceeds used to pay-down debt and fund a special dividend of 15c per share. The Group is now purely focused on its retail and wholesale distribution businesses.
Under Sigma's previous CEO, the Group was focused on growth opportunities in its manufacturing business, essentially using its wholesale distribution business as a loss leader to sell its manufactured products. Following the appointment of Mark Hooper as CEO, the pharmaceutical/manufacturing business has been sold and focus has returned to generating an appropriate return on capital in the wholesale distribution business. Since the sale, Sigma has successfully renegotiated discounts and terms of trade with the majority if its customers, with the expectation that there is opportunity to continue to improve returns in this business.
Sigma has also announced significant customer wins, with a supply deal for generic products with Chemist Warehouse and the recent announcement of a supply agreement for Pharmacy Alliance, which could represent over $250m in revenue.
BAEP believe there is further upside from a reduction in discounts offered to pharmacists. Symbion and API, the alternative wholesale distributors, have also been reducing discounts and the industry is acting rationally in its efforts to improve profitability. Sigma currently has the most generous trading terms among wholesale distributors, but there are significant working capital benefits that could be achieved if Sigma can reduce days/debtors over time.
The key risk for Sigma is if they are unable to renegotiate trading terms with pharmacies to offset the impact of PBS reforms. There is potential for further competition in the distribution chain should other drug manufacturers follow Pfizer's lead and move to direct distribution themselves, however the success of Pfizer's model is yet to be proven.
BAEP continues to expect further upgrades to consensus earnings despite the significant upgrades delivered over the last 12 months. On consensus earnings, Sigma is trading on an FY12 PER of 13x at a share price of 60c with a 6.3% fully franked yield and potential for capital management.
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