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Australian Pharmaceutical Industries profit slumps

Pharmacy wholesaler, Australian Pharmaceutical Industries (ASX: API) has reported a 19.8% fall in full year net profit after tax, despite a 0.4% fall in revenues.

Revenues fell from $3,199 million to $3,186 million, with net profit coming in at $24.3 million, down from $30.3 million in 2012. The company says underlying net profit actually increased 9.6% over last year, from $22.2m, thanks to several one-off items last year.

API says revenues dropped partly because of government reforms to the Pharmaceutical Benefits Scheme (PBS). Wholesalers such as API, Sigma Pharmaceuticals (ASX: SIP) and Symbion are paid 7% of the value of the PBS medicines they distribute to pharmacies. Pharmacy distribution represents the lion’s share of revenues for API, with revenues falling 1.4% to $2,395 million, compared to the previous year. The company’s Priceline pharmacies saw negative 0.4% same store sales growth, but new stores saw sales inch up 2.9% to $676.5 million.

Operating cash flow came in at $66.6 million, allowing the company to pay down $25m worth of debt. Net debt now stands at $117.3 million, and net debt to equity ratio currently sits at 20%. What is concerning for any investor is the company’s return on equity of just 4%, and return on funds employed steady at 8%. Unless the company can lift its returns above its cost of capital, earnings and the share price are likely to go backwards.

API says it is please by the performance of the Priceline Pharmacy business, with 10% growth in its store loyalty program to 4.3 million members. With a net 14 stores opened during the year, Priceline now has 363 stores around Australia, and has its eyes on a further 20 sites.

Chief executive Stephen Roche says the start to the 2014 financial year has been positive with Priceline seeing a 1.9% lift in same store sales for the first seven weeks. But he warned that distribution would face an increased impact from PBS reform measures.

Washington H. Soul Pattinson (ASX: SOL) owns around 25% of API, with API owning and operating the Soul Pattinson branded pharmacies.

Foolish takeaway

With skinny profit margins, API and Sigma will struggle unless they can run an extremely lean business. The problem they face is that the government wants to cut the costs of the $9 billion PBS, which will impact both distributors, while the rise of discount pharmacies will hit the Priceline and Soul Patts business.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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