Why Sigma Healthcare Ltd shares are underperforming the market

Pharmaceutical wholesale and distribution company Sigma Healthcare Ltd  (ASX: SIG) continues to disappoint investors with its share price falling 17% to 73 cents since the release of its full year earnings on March 22. Whilst the ASX200 is down 1% over the last 12 months, Sigma’s share price has substantially underperformed, losing 41% over the same period.

What happened?

The company’s legal dispute with major customer, the My Chemist/Chemist Warehouse Group, acted as a significant headwind during 2017. The Group had indicated that it was intending to source products from another wholesaler which would contravene its service contract with Sigma.

The dispute was finally settled in October where an agreement was reached that My Chemist/Chemist Warehouse would not pursue the procurement of products from another wholesaler for the remainder of the current contract.

However, uncertainty persists regarding the renewal of the service contract with Sigma when the current deal expires in June 2019. The long-standing relationship with My Chemist/Chemist Warehouse is significant for Sigma with annual sales revenue from its major customer totalling $1.69 billion and comprising 41% of the company’s revenues.

Sigma also delivered a disappointing set of numbers for the year ended 31 January 2018, which has seen selling pressure on the stock intensify over the last few weeks.

Revenues for the year declined by 5.4% to $4.13 billion as a result of lower demand for high cost Hepatitis C medications, declining volumes and reduced prices from PBS reforms, the exit of a large customer group in Queensland and the decision by two manufacturers to distribute their products direct to pharmacy.

Sales revenues excluding Hep-C were flat at $3.68 billion. The reduced top line and a jump in operating expenses saw underlying net profit after tax drop 10.5% to $59.9 million.

Foolish takeaway

Sigma’s struggles are similar to its rival Australian Pharmaceutical Industries Ltd (ASX:API), whose share price has lost 28% over the last 12 months as the industry battles a challenging operating environment. Sigma’s management has guided for underlying EBIT in FY19 to be $90 million, which is essentially flat.

At current prices, Sigma is trading at 13 times trailing earnings with a 6.85% dividend attached with full franking credits. With the flat outlook and the uncertainty surrounding the Chemist Warehouse renewal it’s difficult to formulate a long-term bullish thesis for Sigma at the moment. Investors looking for capital growth in the healthcare sector may want to consider other companies with superior growth prospects such as CSL Limited (ASX: CSL).

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Motley Fool contributor Tim Katavic owns shares of CSL Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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