The ASX healthcare player soaring to all-time highs
The steep market reaction comes after a recent announcement by the ACCC.
Mentioned: Sigma Healthcare Ltd (SIG)
Sigma Healthcare Limited (“Sigma”) share price soared to an all time high after the Australian Competition & Consumer Commission (“ACCC”) announced it was seeking market feedback on the contentious proposed merger between Sigma and Chemist Warehouse Group (“Chemist Warehouse”).
The news follows Sigma’s offer to allow its numerous franchised pharmacies to quit the group without penalty to alleviate anti-competition concerns previously outlined by the ACCC.
Sigma Healthcare Limited SIG
Sigma is a full-line pharmaceutical wholesaler and distribution business in Australia, delivering daily to pharmacies Australia-wide. The Group operates Australia's largest pharmacy networks, across Amcal, Guardian, Discount Drug Stores, and PharmaSave.
- Fair Value Uncertainty: Medium
- Moat Rating: None
- Fair Value: $0.78
- Share Price: $1.91 (as at 2nd October 2024)
- Price to Fair Value: 2.4 (Overvalued)
The reverse acquisition
Sigma’s target, Chemist Warehouse is an unlisted, public Australian company. It acts as a franchisor to ~600 pharmacies and retail stores under several banners. The group also owns private label product brands which it sells online and supplies to its franchisees. There are six distribution centres in operation to support the supply of front of store (“FOS”) and over the counter (“OTC”) products to its franchisees.
Last year Sigma announced a five year contract with Chemist Warehouse for the wholesale supply of both Pharmaceutical Benefits Scheme (PBS) medication and Fast Moving Consumer goods (“FMCG”).
The proposed merger outlines Sigma’s intention to acquire all the shares in Chemist Warehouse in exchange for Sigma shares and a $700 million cash consideration. The transaction is in effect a ‘reverse acquisition’ of Sigma by Chemist Warehouse, resulting in the ASX listing of Chemist Warehouse.
Upon completion of the proposal, Chemist Warehouse shareholders will retain ~86% of the ASX listed merged entity while Sigma shareholders will be left with the remaining 14%.
The ACCC’s iron fist
The merger has been riddled with competition concerns voiced by the ACCC at both the retail and wholesale levels. The regulator outlined preliminary concerns in June this year stating that the merger “may substantially lessen competition in pharmacy retailing… which may lead to increased prices for the goods and services provided…”.
In an attempt to ease these concerns, Sigma announced that it will not hinder its franchisees from terminating agreements with Chemist Warehouse and will limit the potential misuse of confidential competitor data that Chemist Warehouse stands to gain from.
In response the ACCC stated they are seeking feedback from stakeholders on whether these terms may address competitive concerns. It is expected that the ACCC will continue review before a final decision on November 7th 2024.
What we think
Sigma's profitability as a stand-alone business has been stagnant. Gross margins in recent first-half fiscal 2025 results fell to 6.5% from 6.6%, driven by a weakening mix shift. Underlying earnings before interest and taxes (“EBIT”) margins are still depressed at 1.0% due to cost inflationary pressures, compared with an underlying EBIT margin over 2% prepandemic.
Despite market reaction, we believe there is a significant risk of regulatory resistance and do not believe Sigma's proposed remedies materially derisk regulatory clearance.
In addition, our preliminary estimate of forecast fiscal 2025 earnings for the merged group implies Sigma's shares are currently trading at a forward P/E ratio of 33 times. This suggests minimal upside if the deal goes through as proposed, outweighed by the significant downside risk if Sigma cannot overcome all ACCC concerns.
The rejection of the deal, as we expect, is a potential catalyst for the share price closing the gap to our fair value estimate of $0.78 per share.
