Sigma's plunge unearths a story of disruption
The loss of a crucial contract this week that took a 40 per cent bit out of Sigma Healthcare (ASX: SIG) points to a larger story of disruption in Australia's pharmaceutical wholesale industry, according to Morningstar analyst Chris Kallos.
The loss of a crucial contract this week that took a 40 per cent bit out of Sigma Healthcare (ASX: SIG) points to a larger story of disruption in Australia's pharmaceutical wholesale industry, according to Morningstar analyst Chris Kallos.
An industry once protected from grocery giants by ownership and location rules is now powerless to stop the proliferation of retail pharmacy chains, he says.
"The Australian pharmaceutical community has historically operated under strict laws that limit ownership of pharmacies to pharmacists – who themselves are allowed to own five pharmacies in any state or territory," Kallos says.
"This has been a barrier to grocery stores like Woolworths and Coles entering the market, and focused traditional pharmacy in the business of relying on prescriptions for the bulk of revenue rather than consumer goods like nappies, perfume and vitamins."
"However, a new breed of discount mega-pharmacies has aggressively entered the market, winning market share based on a discount pharmacy model."
Sigma's shares hit seven-year lows following the announcement of the loss of the Chemist Warehouse contract, plunging 40 per cent to $48.75. More than $300 million was wiped off the company's market capitalisation.
Chemist Warehouse is a good example of this discount mega-pharmacies model, Kallos says. The company, which only operated five stores in 2005, has over the last 13 years expanded its empire to more than 400 outlets across the country. Despite stringent rules, the company has managed to grow through a series of direct ownership and partnerships of pharmacies.
The Chemist Warehouse contract reflected over a third of Sigma's fiscal 2018 revenue, a material loss for the company, according to Kallos.
"This represents a significant blow to the company," Kallos says. "The materiality of the impact to Sigma is reflected in around 41 per cent of its 2018 revenue being composed of the Chemist Warehouse/My Chemist business -- around 400 stores of the 2000 pharmacies serviced by Sigma."
Chemist Warehouse instead awarded the contract to Sigma rival EBOS Group, dual listed on the ASX (EBO) and the NZX (EBO-NZ), who will provide pharmaceutical products Chemist Warehouse and My Chemist stores from mid-2019.
EBOS expects to generate about $1 billion in revenue in the first year of the new contract.
Sigma also announced a cut to its earnings guidance, saying 2018/19 underlying earnings will be $75 million for the current year, down from $90 million, and falling to $40 million and $50 million.
Kallos says the emergence of giant retail pharmacy chains like Chemist Warehouse into the fragmented sector has allowed a single company to move markets.
"Chemist Warehouse made up over 40 per cent of Sigma's group revenue for 2018, a huge concentration risk for the company," he says. "The issue has really shone a light on the sector and issues around ownership laws."
Kallos believes the sector could undergo a period of deregulation of ownership rules when pharmaceutical stakeholders meet with government in June next year to begin negotiations around the next Community Pharmacy Agreement.
Morningstar has lowered its fair value estimate for Sigma to $0.70 per share but expects the company will recover.
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Emma Rapaport is a reporter for Morningstar Australia
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