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Sigma's plunge unearths a story of disruption

Emma Rapaport  |  06 Jul 2018Text size  Decrease  Increase  |  
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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

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication

is an editor for Morningstar.com.au

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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