Aging Population And Store Expansion Will Support Long Term Pharmacy Earnings Resilience

Catalysts

About Sigma Healthcare

Sigma Healthcare operates a large pharmacy franchise and wholesale distribution business focused on community health and medicines.

What are the underlying business or industry changes driving this perspective?

• The aging population and ongoing need for prescription medicines supports Sigma Healthcare’s large Chemist Warehouse, Amcal and Discount Drug Stores networks. This can underpin continued script volumes and front of store demand over time and influence revenue and earnings resilience.
• Growing use of GLP-1 medicines for weight and metabolic health, together with the potential introduction of oral GLP-1s in Australia, supports higher basket sizes and category expansion into complementary products such as protein, vitamins and beauty. This can affect revenue growth and gross profit dollars.
• Continued rollout of new Chemist Warehouse stores in Australia, planned Amcal and DDS onboarding, and a growing international footprint across New Zealand, Ireland, the UAE and entry into the U.K. expand Sigma Healthcare’s reach. This can influence top line growth and operating leverage.
• Expansion of owned and exclusive label products, including Wagner generics and other higher margin ranges, increases product differentiation and mix. This can impact gross margin and EBIT margin as penetration scales within the overall sales base.
• Ongoing consolidation of distribution centers, SAP integration across the merged group and the targeted A$100m per annum synergy program create scope for lower unit costs and better inventory efficiency. This can affect net margins, cash conversion and returns on invested capital.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Sigma Healthcare's revenue will grow by 10.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.5% today to 7.9% in 3 years time.
• Analysts expect earnings to reach A$1.2 billion (and earnings per share of A$0.1) by about September 2029, up from A$709.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 38.9x on those 2029 earnings, down from 43.3x today. This future PE is lower than the current PE for the AU Healthcare industry at 39.1x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.18%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• GLP-1 medicines are currently a strong driver of Sigma Healthcare pharmacy traffic and larger baskets, yet management highlights that GLP-1 sales dilute gross margin percentage and that future oral GLP-1 pricing and funding are unknown. Any change in demand, pricing or reimbursement could weigh on revenue growth and compress gross margin and EBIT margin over time.
• The long-term plan relies heavily on sustained double digit like for like sales growth in Chemist Warehouse and ongoing rollout of new stores across Australia, New Zealand, Ireland, the UAE and the U.K. Any slowdown in store openings, weaker like for like growth or underperformance in new international markets could reduce operating leverage and limit growth in revenue and earnings.
• Working capital intensity is increasing, with net working capital at about A$1.6b, inventory up 22% and the cash conversion cycle at 54 days, and management is still working toward a single SAP system. Any difficulty in reducing inventory days or optimizing the enlarged supply chain could constrain cash flow, increase funding needs and pressure net margins.
• International expansion is still in an early phase, with Ireland only recently moving to profit and the planned U.K. entry expected to be loss making for a period. Slower than expected scaling, higher operating costs or store closures in new regions could dilute group margins and slow growth in group EBIT and NPAT.
• The growth model depends on large scale, a discount price position and continued progress on the A$100m per annum synergy program from distribution center consolidation and back office integration. Any delay in capturing synergies, cost overruns from integration or increased competitive pricing pressure could offset efficiency gains and limit improvements in EBIT margin and returns on invested capital.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of A$3.2 for Sigma Healthcare based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$3.8, and the most bearish reporting a price target of just A$2.6.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be A$14.7 billion, earnings will come to A$1.2 billion, and it would be trading on a PE ratio of 38.9x, assuming you use a discount rate of 7.2%.
• Given the current share price of A$2.67, the analyst price target of A$3.2 is 16.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.