EUR 850.00 For Business Accounts Only

Morningstar | Ebos' 1H19 Reveals Ongoing Pressure on Pharmaceutical Distributors. See Updated Analyst Note from 20 Feb 2019

We have remodelled key assumption drivers and changed our forecasts to Australian dollars from New Zealand dollars to align with Ebos' recent change of reporting currency. These modelling changes, combined with updating forecasts following fiscal 2019 first-half results, lifted our valuation to AUD 20 (NZD 21 per share using a spot AUD/NZD exchange rate of 1.04) from AUD 19. We lowered the five-year revenue compound annual growth rate to 5% from 6% to reflect the subdued pharmaceutical distribution industry outlook. However, this was more than offset by our increased average EBIT margin forecast to 3.4% from 3.2% for the next five years, driven by cost efficiencies, growth in higher-margin pet care and consumer brands, and contributions from recent acquisitions of relatively high-margin businesses. We reduced our fair value uncertainty rating to medium from high, reflecting lower expected earnings volatility for the mature and highly regulated pharmaceutical wholesaling segment.

Ebos delivered underlying EBITDA of AUD 131.4 million and underlying net profit of AUD 72.7 million for the first half of fiscal 2019, both up 4% on the previous corresponding period, tracking in line with our full-year forecasts. The 2.7% drop in revenue was largely due to a reduction in hepatitis C sales and Pharmaceutical Benefits Scheme price reforms affecting the healthcare business. Ebos' declared NZD 34.5 cents per share interim dividend was up 4.5% on the previous corresponding period, imputed to 25% for New Zealand shareholders and fully franked for Australian shareholders. We assume the dividend payout is maintained at 70% for our forecast period.

The Australian pharmaceutical distribution industry continues to face headwinds from intense competition and PBS reforms, plus potential disruption from direct distribution by pharmaceutical manufacturers.

Total pharmacy revenue was dragged down by an AUD 78 million decrease in hep C and an AUD 83 million decrease due to PBS reforms, leading to a 6.3% drop in community pharmacy revenue. Excluding hep C and PBS reforms, underlying revenue growth was 1.8%, slightly below our expectations. The institutional healthcare division grew 4.4% in gross operating revenue, underpinned by solid performance of HPS, Symbion Hospitals, Onelink, and Zest. We expect the improving cost efficiencies flowing from automation, as well as the acquisitions of higher-margin Terry White Group and Warner & Webster, to support margins for the healthcare business. We forecast EBITDA margin in healthcare to average around 3.4% over the next five years, compared with the 2.8% three-year historical average.

Despite accounting for a smaller portion of group EBITDA, the exposure to pet care and consumer brands reduce Ebos' reliance on the relatively lower-margin pharmaceutical distribution business. We forecast EBITDA margin for the pet care division to trend up to 13% from 12% in the next few years with the company's concerted focus on higher-margin premium pet products. The consumer products division delivered strong 9.6% revenue growth for the half, mainly driven by Red Seal's strong sales both domestically and internationally and acquisition of Gran's Remedy.

With an AUD 120 million increase in net debt related to acquisitions and investments during the period, the net debt/EBITDA ratio grew to 2.2 from 1.7 at June 2018. Acquisitions remain a focus area of management to diversify the income streams, offer cross-selling opportunities, and leverage the company's distribution network. The AUD 16.9 million of capital expenditure was primarily due to the final payments for the new Brisbane distribution centre. The 0.2% drop in return on capital employed to 16.1% is reflective of the increased investment in net working capital during the period.