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Morningstar | API's Slower Growth Outlook Triggers FVE Cut to AUD 1.80 per Share

We reduce our fair value estimate for narrow-moat Australian Pharmaceutical Industries, or API, to AUD 1.80 per share from AUD 1.95 following its weaker-than-expected fiscal 2018 result. Underlying net profit after tax of AUD 54.7 million, 0.9% up on the previous year, was 2% below our forecast. The miss was mostly top-line-driven, with group revenue of AUD 4.0 billion, falling 0.9% from last year. The revenue reduction was largely attributable to weaker demand for hepatitis C medicines, with revenue falling AUD 155 million. Excluding hepatitis C, revenue would have increased by 3.3% on the prior period. Nevertheless, this was still 5% below our forecast. The final fully franked DPS of AUD 4 cents took total dividends for the year to AUD 7.5 cents, an increase of 7% and based on a 77% payout. At current prices, the stock is trading close to our revised intrinsic assessment.

API remains highly leveraged to the Australian pharmaceutical wholesale market, with over 70% of revenue and nearly half of gross profit generated from this space in fiscal 2018. We have reduced our five-year revenue CAGR forecast to 1%, from 1.5% previously, for the division. This reflects the increasingly competitive industry landscape and the larger-than-expected continuing impact from the recent Pharmaceutical Benefits Scheme, or PBS, changes, as well as the hit from certain pharmaceutical companies directly distributing their products.

The Priceline Pharmacy Network added only 13 new stores in fiscal 2018, below the company's previous target of 20 new stores, bringing total franchisee stores to 475 across Australia as at the end of fiscal 2018. We now expect API to roll out Priceline Pharmacy stores at a slower pace than our previous expectations. This is due to the tough retail trading conditions (retail like-for-like sales still negative) and management’s intention to secure optimal sites with more consideration to size and location than just the number of new stores.

We have reduced our annual growth forecast for Priceline stores to 10-12 from 20. This is the second key driver of our fair value estimate downgrade. On a positive note, we still expect diversification into non-PBS-related revenue to stabilise margins at around current levels. The retail division accounted for only 28% of revenue but generated close to half of gross profit in fiscal 2018, underscoring its importance to group profitability.