De Alwis tries to sweeten Sigmas bitter pill

The growth that we have experienced over the last six weeks over the comparable period last year has been encouraging.

Sigma is going to need a long run of encouraging performance if it is to claw its way back from the 48 per cent share-price fall that greeted the full-year profit result. Forget the goodwill write-downs, De Alwiss real problem is a startling decline in profitability and cash flow.

Underlying profit after tax for the year ended January 2010 came in at $67.7 million, down on $80.1 million in the previous year. The companys cash-flow performance was even worse. Cash flows from operating activities were a dismal $19.2 million as working capital requirements ballooned after customers refused to participate in Sigmas attempts to window-dress the full-year result by pulling sales forward into December and January.

It is these figures that explain the share price fall. At yesterdays closing price of 46.5? the market is valuing Sigma at $548 million a 2010 price-earnings multiple of eight times, but a (still too high) 28.5 times operating cash flow.

Listen to the company, and the worst is over. Company budgets suggest that current year profitability will broadly match the $80.1 million achieved last year, and strategies are in place to claw back working capital requirements.

De Alwis reckons deals have already been struck with the companys two largest pharmacy clients that will see working capital reductions of about $75 million in the current year. This must involve a substantial reduction in the six-month payment terms that were previously on offer to clients including Chemist Warehouse and myChemist. But it was Sigmas generous trading terms that underwrote the rollout of these brands.

But will Sigma keep its customers once trading terms are wound back?

Sigma also has its work cut out in keeping the banks off its back. They may have forgiven the year-end covenant breaches, but the company still has to offload assets valued at $90 million in coming months, and to have a strategic review of the business completed by an investment bank, possibly Lazard, within 90 days.

The fine print of Sigmas accounts will be well read this year. When shareholders see that directors recognise a risk of covenants, particularly the reset interest cover ratios and the recently introduced requirement to sell non-core assets, being breached in the future theyll be sure to wonder whether these words are a boilerplate disclaimer or a truer sign of things to come than De Alwiss vaunted six weeks of good trading.

Rock and a hard place

DIRECTORS of Macarthur Coal have rejected Peabody Energys unsolicited proposal to acquire the company for $13 a share. But the market is sending a clear message that Macarthurs preferred transaction, the acquisition of Gloucester Coal, is dead.

Gloucester shares fell 10 per cent on news of Peabody Energys interest in Macarthur, while Macarthur shares rallied 16 per cent to $14.05 as the market punts that the Peabody proposal is just the opening gambit. Peabody Energys interest in Macarthur is conditional on the Gloucester deal not taking place.

This timing of the proposed Gloucester acquisition places the Macarthur board in an unusual position, having just 12 days to negotiate an acceptable deal with Peabody Energy.

The timeframe is so tight because a meeting of Macarthur shareholders has been convened for April 12 to approve aspects of the Gloucester deal that would see Gloucesters major shareholder, Hong Kongs Noble Group, emerge as a 24.4 per cent shareholder in Macarthur. If the vote goes through, Macarthur would have an obligation to complete the Gloucester takeover.

While the Macarthur board has rejected the Peabody offer, it is negotiating with one hand tied behind its back. Arguing that the $13-a-share offer price is inadequate is tough when Macarthur released an independent experts report in relation to the Noble deal in late February that values Macarthur at between $9.84 and $12.49 a share. Coal prices may be moving upwards every week, but it is hard to argue that a company valuation would have shifted materially in just six weeks.

With the independent expert providing little assistance to the Macarthur board, its time for the companys advisers at JP Morgan to start the search for counter-bidders.

Fire sale at Griffin

REPORTS out of Western Australia suggest that, after a few weeks delay, the Griffin Coal administrator has appointed UBS and Macquarie Capital Advisers to run a sale process for the sprawling empire.

The prospect that a sale will see creditors paid in full is looking increasingly doubtful, with analysts from Debtwire suggesting that cash costs at the companys mine are unsustainable. The risk is that Griffin will have negative cash flow from mid-year when a lucrative contract to supply Verve Energy with coal at $80 a tonne expires. Apparently Griffin will then be left with off-take agreements priced at $31.70 to $41.50 a tonne. Several of the companys bondholders have recently estimated Griffins production costs at $35-40 per tonne.

dsymons@fairfaxmedia.com.au