Chemist giants go head to head
The My Chemist Group and Terry White Group are assessing the pros and cons of joining Australian Pharmaceutical Industries (API) and Sigma Pharmaceuticals on the Australian Stock Exchange (ASX).
According to IBIS World, the My Chemist Group, which includes the big footprint Chemist Warehouse stores, has a market share in retail pharmacy of around 23.3 per cent
The Terry White Group has a 10.2 per cent market share after its 2016 merger with the Chemmart chain that now has most of its 500 pharmacies trading under the TerryWhite Chemmart banner.
Sigma Pharmaceuticals’ market share of retail pharmacy is estimated at 19.3 per cent, with revenues largely derived from five key brands – Amcal, Guardian, Chemist King, Discount Drug Stores and PharmaSave.
Sigma Pharmaceuticals is also a wholesale supplier to independent pharmacies and re-signed the My Chemist Group to a supply contract in February last year.
The best of frenemies
My Chemist Group founders Mario Verrochi and Jack Gance were long-term customers of Sigma Pharmaceuticals trading under the Amcal banner before forming My Chemist and, later, Chemist Warehouse.
The relationship between the two parties has had some awkward moments with the My Chemist Group, along with many other smaller pharmacy chains, impacted when the wholesaler tightened its trading terms after incurring massive losses.
Extended trading terms had been used to lock in customer loyalty and spawned a number of smaller pharmacy banner groups which collapsed when Sigma Pharmaceuticals cut back the generous concessions to ensure its own survival.
The My Chemist Group relationship with Sigma Pharmaceuticals was again strained last year when the wholesaler initiated legal action over supply arrangements the retail group attempted to pursue outside the February 2017 contract.
Those legal proceedings were withdrawn after the two parties reached a settlement last year but the future of the relationship is not assured.
The fourth major player in retail pharmacy, Australian Pharmaceutical Industries (API), is also a wholesaler with independent chemists augmenting its revenues from Priceline, Soul Pattinson Chemist, Pharmacist Advice and Pharmacy Best Buys.
API, according to IBIS World, has a 10.2 per cent market share in retail pharmacy.
On Monday, Priceline delivered a profit warning to the market, saying that poor Christmas trading had driven its half-year profit guidance down 9 per cent on last year.
Year-to-date network sales, including dispensary, are up two per cent, while like-for-like retail sales within the network have declined 2.4 per cent in the first half.
The pharmacy sector has been more resilient than other retail categories in recent years, but the aggressive expansion of the My Chemist Group, The Terry White Group and Priceline and the regrouping of Amcal, have impacted the viability of independent pharmacies.
The Melbourne-based My Chemist Group is estimated to be generating around $4 billion in annual sales and has grown the Chemist Warehouse steamroller from just five stores in 1995 to more than 300 today.
My Chemist Group is understood to have started sounding out financial advisers and investment bankers late last year on a prospective float on the ASX, which has suggested an enterprise value of as much as $5 billion.
A trade sale would also be possible and although the price is high, the market position and category growth potential might tempt Wesfarmers, Woolworths or an international pharmacy group with the American retailer, Walgreen, one possible contender.
A float of the group known as the “Bunnings of pharmacy” could have major implications for the category, including a change to ownership and pharmacy location restrictions imposed by state and Federal Government legislation, regulations and pharmaceutical benefit scheme funding agreements.
A float would be expected to generate capital for further expansion in Australia, New Zealand and, possibly other overseas markets, particularly through online retail platforms such as the ecommerce site established in China in a partnership with the Alibaba Group’s Tmall Global.
Apart from its retail pharmacy brands, the My Chemist Group also owns a chain called My Beauty Sport and ePharmacy and is expanding this year under a franchise agreement into Malaysia with Chemist Warehouse Berjaya Asia.
It would also provide the current owners with an opportunity to unlock some, if not all, of the equity they have in the business.
A float of the My Chemist Group would be the most significant retail listing on the ASX since the Myer 2009 listing, but would be expected to generate greater investor confidence as a growing enterprise compared to the uncertain prospects of the department store group.
A change in business model
However, a stock exchange listing may not be straightforward with My Chemist Group directors and their financial advisors will potentially need to reconfigure the business model that allowed the company to cleverly circumnavigate the pharmacy ownership restrictions.
The last retailer that had to unravel a franchise structure to prepare for a public float was The Good Guys, the electrical chain that was instead acquired by JB Hi-Fi.
The Good Guys franchise structure was a business model preference, whereas the My Chemist Group’s structure has been an adaption to the pharmacy ownership restrictions imposed by legislation.
The My Chemist Group is ultimately controlled by an entity called East Yarra Friendly Society, which Gance and Verrochi acquired in 2002.
At the time, friendly societies were not restricted in the number of pharmacies they could own and the then-dormant East Yarra Friendly Society provided the initial platform for expansion.
Subsequently, Chemist Warehouse has developed a franchise system to allow the chain to expand without offending the pharmacy ownership restrictions.
The My Chemist Group float and a potential public listing by the Terry White Group may force a further examination by health ministers of pharmacy ownership restrictions and their effect on retail competition and pricing of drugs that the Federal Government subsidises through the PBS.
While the Pharmaceutical Society and Pharmacy Guild defend the existing restrictions on pharmacy ownership, there are other health sector voices, including the Royal Australian College of General Practitioners, who argue they should be abandoned.
There is also a potential threat to the two prospective floats of health ministers revisiting the 2016 Pharmacy Remuneration and Regulation review panel recommendations on product restrictions and PBS funding cuts if pharmacies did not maintain a maximum ratio of retail space to the professional dispensing area within stores.
The impractical recommendation, described by the Pharmacy Guild as “idealogically driven”, is never likely to win political favour, but government intervention in the pharmacy sector is a risk factor for investors to consider.
On the pharmacy ownership issue, for instance, there is the continuing interest of the major supermarket chains in in-store pharmacy concessions as well as other healthcare providers and, prospectively, internet vendors.
Terry White to double down
Terry White Group has indicated it has a stock exchange listing as an option to fund a growth target in the next two years of 25 per cent market share with 1,000 pharmacies, effectively double the current store network.
Terry White Group’s merger with Chemmart in 2016 was a key element of a strategy for the Brisbane-based group to build sufficient scale to compete with the My Chemist Group.
The Terry White Group also operates on a franchise structure and following the merger of Terry White Chemists and Chemmart, generates annual sales of around $2 billion.
While a stock exchange listing is current director and management thinking, there is always the possibility of a trade sale for the Terry White Group, especially if a private equity firm saw an opportunity to mop up either Sigma Pharmaceuticals or API to create a stronger competitor to Chemist Warehouse.
The opportunity to rationalise the retail pharmacy market, which boasts genuine growth prospects that have not been realised in most retail floats on the ASX of recent years, would be enticing and unlikely to generate competition concerns.
It is an opportunity that might also be considered by Wesfarmers and Woolworths or even the grocery and hardware wholesaler, Metcash, that has previously discussed a buyout of Sigma Pharmaceuticals.