Sigma told to 'lick wounds' after Chemist Warehouse hammering

Sigma Healthcare's largest investor says the company should take time to lick its wounds rather than rush into new investments, after the loss of its biggest contract cut it projected earnings in half and sent its share price plunging 40 per cent in a single day.

The pharmaceuticals supplier on Monday revealed it had lost its contract with Chemist Warehouse, which will instead sign a five-year contract with the rival EBOS Group to distribute drugs to more than 400 Chemist Warehouse and My Chemist stores.

The loss of the contract with Chemist Warehouse hit Sigma's earnings guidance. Credit: Kate Geraghty

Sigma drastically lowered its outlook off the back of the announcement, cutting guidance for 2019 underlying earnings before interest and tax from $90 million to $75 million, and earnings for 2020 to between $40 million and $50 million - about half its earlier guidance.

The company's shares were punished, falling 40 per cent from 81¢ to 48¢ - wiping $345 million off its market value.

“It’s been a very painful ride for us today", said Simon Mawhinney, the managing director of Sydney-based investment fund Allan Gray, which is Sigma’s largest investor with 16.5 per cent of stock.

“I think the sharemarket has reasonably fairly dished out its assessment of the news."

However, Mr Mawhinney said Sigma's management had acted commendably by rejecting the uneconomic terms that management said Chemist Warehouse was demanding.

“So what the management team has done is the right thing - but it doesn’t change the outcome," Mr Mawhinney said, who added that an unanticipated weak trading update had “rubbed salt into the wounds” of investors.

Sigma’s chief executive Mark Hooper described the loss of the contract as "an important pivot point for Sigma".Credit: Mathew Lynn

Sigma's chief executive, Mark Hooper, said renewing the contract would have resulted in a $40 million deterioration in Sigma's earnings, while describing the loss of the contract as "an important pivot point for Sigma".

“We are not prepared to risk significant shareholder funds without adequate and sustainable returns," he said.

The contract loss meant that more than $300 million in cash would be freed up at the end of the contract in mid-2019, and Mr Hooper said the company would look for new investments and possibly aquisition to drive growth.

“It gives us a very powerful war chest to go and invest with," he said. "But that same discipline that applied to this particular decision will apply to anything we look at - it needs to deliver the right level of return."

But Mr Mawhinney said it was "not a bad time just to pause and lick one’s wounds" rather than rush into a new investment.

"In this environment of high asset prices… it’s optimistic to think that $300 million can be re-deployed easily and effectively," he said.

"Going out and taking the $300 million and buying something to fill a $30 million or $40 million earnings hole isn't going to be as easy as it sounds.

“It does offer them some flexibility but the last thing we would want from the company is for them to go and squander that."

Mr Hooper said that while it was a "step back" in Sigma's short-term financials, losing the contract "improves the risk profile of our earnings and also releases significant capacity to better leverage our infrastructure and resources in areas that can provide long term sustainable growth."

EBOS’s five-year agreement with Chemist Warehouse will take effect from July 1, 2019. The company estimates that sales to the Chemist Warehouse Group stores will generate about $1 billion in revenue in the first year of the five-year agreement.

EBOS, which has a dual listing on the ASX and the New Zealand Stock Exchange, currently operates the Symbion pharmaceutical business and has a 50.1 per cent stake in the Terry White Chemmart Group that operates about 500 retail pharmacies across Australia.

The company said in a statement that since it acquired Symbion in 2013, EBOS had grown to become a leading marketer and distributor of pharmaceutical products, with annual sales revenue of about $NZ7.5 billion and a market capitalisation of $NZ2.7 billion.

“Continuing to grow our Healthcare business remains a high priority for the group and partnering with Chemist Warehouse Group will be a natural progression of that,” EBOS chief executive John Cullity said.