How Chemist Warehouse passed the pub test
The founders of the retail juggernaut have got bigger by sticking close to their market. Now Chemist Warehouse faces the ultimate test.
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From a low-rise pub on an industrial strip in Melbourne’s north, an ASX giant has emerged.
The Olympic Hotel is known among locals for its honest chicken parmigiana and the big lunch special. There’s pokies out back and racing beamed into the sports bar.
Less well known is The Olympic’s role in playing host to meeting where billionaires are made. It was on Wednesday night and it took just 15 minutes for about 100 or so deeply private owners of national retail juggernaut Chemist Warehouse to vote for it to become a $34bn listed company.
That’s a company twice the size of Qantas and bigger than global names like Brambles and James Hardie. It puts Chemist Warehouse a fraction behind Woolworths and well ahead of Coles. The listing is not through the usual path of an initial public offer, rather Chemist Warehouse is doing what it does best – bulking up. That’s through the reverse buyout of listed pharmacy wholesaler Sigma.
But for co-founder Mario Verrocchi it’s more than a business.
“We’ve got 600 babies,” he tells The Australian shortly before the meeting. That’s the number of stores across Australia and New Zealand and he can name every one.
Often likened to the Bunnings of pharmacies, Chemist Warehouse has been able to grow the same way as the hardware chain. It uses its scale as brute force when it comes to striking supply deals. It has also moved aggressively into private label brands. This means customers are getting a better deal on goods where the mark-up has traditionally been high, while Chemist Warehouse also gets to protect its margins.
There’s good reason why co-founders Jack and Sam Gance as well as Verrocchi chose The Olympic in Preston to hold the vote.
“Our head office is about 100 metres just up the road,” Verrocchi says pointing back across Bell Street. Each are now multi-billionaires - on paper - but it’s all from small beginnings.
The first chemist outlet the Gance brothers operated more than five decades ago was also just up the road in the other direction at the then working class Reservoir where they were soon joined by Mario in the business.
There they quickly discovered the power of scale as they opened their second store across other side of the train tracks that splits the suburb. Then there was a third store in the sprawling Northland shopping mall, a stone’s throw from The Olympic. As they built out the business, they invited other chemists to join on the buying network.
There’s also a compelling economic argument for the location. Chemist Warehouse is ruthless on costs. Why hold a meeting in an overpriced city hotel when The Olympic will do just fine? Sigma, which held a separate meeting to approve the merger on Wednesday, held its vote in town at the Sofitel on the top of Collins Street.
Chemist Warehouse was long speculated as a candidate for a stockmarket listing, although those close to it reasoned it was never going to happen. The founders were too private and the generational change is underway. Sam Gance’s son Damien is chief operating officer.
That’s why they took many by surprise when nearly 14 months ago they not only pushed the button on a listing but doing it by combining with Sigma. In essence it’s a backdoor listing, with Sigma issuing shares to fund the deal. Ultimately Chemist Warehouse and its backers – including the Gances and Verrocchi and the franchisees built up along the way will own 85 per cent of the merged company and Sigma’s existing owners 15 per cent of a bigger pie.
Even today they know the value of a store, including sweating every inch of retailing space.
There’s more than 600 Chemist Warehouse franchises across Australia and New Zealand. It’s pushed oversees with 10 in Ireland, one in Dubai and is quietly pushing into China. The biggest success is its deal with Chinese e-commerce major Alibaba, where Chemist Warehouse is one of the top selling international retailers on the TMall site. In Australia it operates its own booming online platform.
It’s only through the merger with Sigma that investors have been able to get a look at the Chemist Warehouse financial engine. And there’s an impressive engine inside.
Last year Chemist Warehouse delivered revenue to more than $3.2bn and a staggering pre-tax profit of $581.5m. That means nearly 20 cents in every dollar trickles down into the earnings line. Revenue in the past decade years are growing at an annualised rate of 13.5 per cent. It has almost no net debt on the balance sheet and its sitting on nearly $300m in cash.
All upside?
The question that has to be asked is whether the best of Chemist Warehouse’s growth is behind it. The retailer has command of the physical market and now a Wesfarmers-backed Priceline is also intent on expansion. Amazon is also pushing aggressively into health and beauty products in Australia.
Its accounts show a business that is maturing where earnings margins have started to pull back in the past three years and the pace revenue growth has slowed, albeit from a fast rate.
At the same time, NSW remains a harder market for Chemist Warehouse given the state has some of the toughest laws relating to pharmacy ownership. Worrying under the Sigma deal, the NSW regulator takes very a dim view on franchise applications where both the pharmacy supplier and operator of the chemist maintain a financial interest. This has slowed the rollout of Chemist Warehouse across what is potentially its biggest market.
“There’s plenty of runway ahead,” Jack Gance tells The Australian. “And then there’s plenty of international runway, which we are dabbling in.”
At the same time there’s options for brownfields expansion – where an established Chemist Warehouse literally leases the store next door and expands the footprint. That’s delivered a recent boost
There’s two other near-term challenges. The first is the execution of a deeply complex merger. Sigma runs on much skinnier margins, with a target of between 1.5 per cent and 2.5 per cent – compared to Chemist Warehouse’s double digits. The addition of Sigma will drag down the average margin.
Sigma’s core business is built around wholesale and distribution which has ceded ground to big players like Chemist Warehouse. Sigma also sits behind two retail franchise networks Amcal and Discount Drug Stores, which combined have hundreds of stores. There will be work to do in combining the two businesses without it becoming too much of a distraction of the core business.
Over time the combination of the two businesses has promised run rate annual synergies of $60m, although this could be higher in the near term.
The other challenge is the transition of fast-growing business that has flown under the radar for decades into the discipline of the public market that comes with six-monthly profit results, ASX announcements and endless analyst briefings. However, Sigma’s chair Michael Sammells will continue in the role, so too will CEO Vikesh Ramsunder. But four of the five executives of the new entity will come from Chemist Warehouse, including Damien Gance. Damien says running a chemist is about having good governance to begin with.
Still, the market is well on board. Since the merger deal was announced in December 2023, Sigma shares have surged nearly 300 per cent, compared to a 17 per cent rise in the ASX over the same period.
“This isn’t necessary the finish line,” Verrocchi says of the vote. “This is just a new beginning, and it’s an exciting new beginning.”
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Originally published as How Chemist Warehouse passed the pub test
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