Sigma Pharmaceuticals is keeping the market waiting for an update on earnings for the year to January. The healthcare company had previously provided guidance for a slight increase in annual profits but expectations are now more subdued, with the company suspended from trade after first requesting a trading halt to allow an earnings update to be finalised on Thursday.
When the downgrade comes, it is expected to be the last that Elmo De Alwis unveils as chief executive at Sigma. De Alwis presided over two downgrades in 2007, and this time investors (fresh from supporting a $297 million capital-raising at $1.02 a share in September) are agitating for change at the top.
The company has provided few clues in advance of the formal announcement, but industry sources were yesterday tipping that the most immediate basis for the company's problems is a practice of forward selling - encouraging customers to place large orders immediately before Sigma's year-end to help the company hit its numbers.
It is well recognised by sector analysts that Sigma has been forward selling for years, but the speculation is that this year a big customer refused to place the order that Sigma was looking for, with a substantial impact on the company's profitability.
This is a plausible cause of earnings weakness, but does not explain the timing of the downgrade, or the need for Sigma to spend several days suspended from trade. A poor January sales result should have become clear within a few days of the company's year-end, with updated earnings guidance available by mid-February.
Sigma shares last traded last Wednesday at 90c.
BAD MEDICINE
Continuing poor profitability at Sigma raises questions regarding the structure of the generic pharmaceuticals industry in Australia. This is a business that has been a focus for the company in recent years, with disappointing results despite what appears to be generous government support in the area.
It seems that the competitive dynamic has changed since Sigma entered the generics industry in 2005 with the $700 million purchase of Arrow Pharmaceuticals. At the time, increasing demand for generics was forecast to provide the merged company with a new growth engine.
In fact, the opposite is true. Sigma generates gross profit margins of just 10 per cent in parts of its generics business, leading to break-even profitability after factoring in distribution and administration expenses. Five years on, the Arrow acquisition looks to have been grossly overpriced.
Sigma's poor performance is at odds with the magnitude of Pharmaceutical Benefits Scheme payments for generic drugs. A recent government report highlighted that Australia is paying $44.45 for a pack of 40mg simvastatin pills (a cholesterol drug) for which the British government would pay just $2.74.
The cost of buying mainstream generics from low-cost factories in Europe and India is not high, and the British pricing broadly reflects the cost to Australian generics distributors of importing product into the country.
So why aren't generics companies making any money? It seems that the competitive dynamic has changed in recent years as new entrants, including both low-cost distributors and local arms of international manufacturers, have been attracted by the industry's high growth. A desperate battle for market share has ensued, with the primary basis for competition being the proportion of government-regulated sales receipts that are paid away as rebates to pharmacists. As a result the generic drug distribution industry is barely profitable, while pharmacies derive an increasingly large proportion of profits from generic drug kickbacks.
Research recently undertaken for a generic drug distributor suggests that as much as 30 to 50 per cent of the net profit of an average pharmacy can be attributed to rebates paid by the generic drug distributors. This far exceeds the dispensing fee of a few dollars per script envisaged by the government funding scheme.
THE HEAT IS ON
Yesterday's announcement by Petratherm that it has achieved commercially viable well temperatures at its Paralana geothermal project in the north Flinders Ranges was greeted by the market with a big yawn.
Are investors missing something here? Petratherm operates Paralana in a joint venture with TRUenergy and Beach Petroleum, and is now one of only two geothermal companies in Australia - the other being Geodynamics - to have conclusively demonstrated the required heat energy to run a large-scale power plant.
Data released yesterday proves a temperature of 191 degrees Celsius at a well-depth of 4000 metres, comfortably in excess of the minimum temperature required, and represents a significant de-risking of Petratherm.
Commercial generation of electricity using geothermal techniques kilometres below the earth remains unproven in Australian conditions and Petratherm's next challenge, before claiming proof of concept, is to show that it can fracture the rock at the base of the well and achieve the required flow rates.
If proof of concept is achieved later this year as forecast, Petratherm can begin constructing Australia's first commercial-scale (30MW) geothermal power plant as soon as next year.
dsymons@fairfaxmedia.com.au
