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Why the Sigma Healthcare Ltd (ASX:SIG) share price crashed 40% today

Shares in Sigma Healthcare Ltd (ASX: SIG) crashed 40% lower to $0.48 on Monday morning’s trade, after the pharmaceutical distribution company announced it won’t renew its wholesale supply contract with the My Chemist/Chemist Warehouse Group.

The current deal expires in June 2019, and after months of negotiations the two parties failed to agree on an extension. In 2017 the exclusive position of Sigma as a wholesaler for the group was the subject of a legal dispute that was eventually settled, but left doubts over the renewal of the contract.

Losing a client like Chemist Warehouse – Australia’s largest pharmacy retailer – will reflect negatively on the company’s earnings, which are already affected by a shortfall in sales.

Sigma slashed its FY19 EBIT guidance to $75 million, down from the previous forecast of $90 million, and from the $99 million of FY18.

The company reported adverse market conditions in the last two months, including the negative effect of price adjustments within the Pharmaceutical Benefits Scheme. “This continues to reinforce the need for government reform to introduce a margin floor for PBS wholesalers in line with the arrangements already enjoyed by pharmacists” commented CEO Mark Hooper.

But the full impact of the separation from the Chemist Warehouse will emerge after the end of FY19, when the supply contract will actually expire. For FY20, the company expects EBIT of between $40 million and $50 million.

From Sigma’s perspective, the proposed terms for a renewal didn’t provide an adequate return on invested capital. Instead, the conclusion of the contract will free up $300 million cash, to be invested in the rationalisation of Sigma’s network of distribution centres and the pursuit of alternative sales opportunities, including hospitals.

The flip side of Sigma’s tumble is the 5% surge of the EBOS Group Ltd (ASX: EBO) share price. The New-Zealand based pharmaceutical distributor will supply Chemist Warehouse for five years starting in July 2019, with a possible 3-year extension.

Foolish takeaway

Although Sigma presented the contract loss as an occasion to move to a new strategy and confirmed the intention to continue paying a high proportion of profits as franked dividends, I don’t see this crash as a buying opportunity.

The stock might partially recover in the next few days, but Sigma confirmed trading conditions remain weak, aside from today’s news.

I’d rather consider an investment in one of these three blue chips tipped to outperform the market in 2018.

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Motley Fool contributor Tommaso Autorino has no position in any of the stocks mentioned. 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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