Disruption’s a bitter pill for the pharmacy market

The $15 billion pharmaceuticals and healthcare distribution market was thrown into turmoil yesterday.

Sigma chief Mark Hooper. Illustration: Sturt Krygsman.

The $15 billion pharmaceuticals and healthcare distribution market was thrown into turmoil yesterday when EBOS boss John Cullity snared Sigma’s major customer, Chemist Warehouse, and in the process, 40 per cent of its revenue base.

Sigma’s Mark Hooper is facing his biggest crisis since the financial scandals that rocked his company back in 2010.

Yesterday he declared his company was now at a “pivot” point as it works out where to go next.

The former mining industry executive cut his teeth trading diamonds with the likes of the De Beers so the latest blow was probably not totally unexpected.

Once again talk will start about industry rationalisation. It has bubbled beneath the surface since the ACCC quashed the proposed API-Sigma link some 18 years ago.

A new player has emerged in the market and disrupted the cosy oligopoly, even if yesterday’s move could be seen as a mere shuffling of the deck chairs.

Chemist Warehouse was started in around 2000 by Jack Gance and Mario Verrocchi on the back of some renegade Amcal pharmacists.

Amcal is a key banner group for Sigma, so the business has been with it for some 40 years, and out of nowhere in the last 18 years Gance and Verrocchi have gone from nothing to $5bn in sales.

The Warehouse team work on transactions, and the concept of business goodwill in dealing with partners is not very evident in its textbooks.

The writing was on the wall for Hooper last year when he took it to court over a generics deal it was doing with smaller rival Clifford Hallam.

That dispute was settled out of court and when Verrocchi rang Hooper last Friday night his message was, while not unexpected, a big blow to the business.

Yesterday’s stockmarket moves told the story with Sigma down 40 per cent while API, which had rallied strongly on a skin care deal, fell 6.8 per cent almost in sympathy.

EBOS was the winner, up 4.9 per cent at $17.70 a share.

EBOS’s Cullity rejected the implication from Sigma that his five-year contract was unprofitable, noting that since 2014 his earnings before interest, tax, depreciation and amortisation increased from $175 million to $270m while return on capital increased from 12 to 16 per cent.

The message being EBOS doesn’t do uncommercial deals.

EBOS, which acquired Symbion back in 2013, has boosted its business through back-of-house efficiencies under John Cullity, the former CFO who now runs the company IT.

The company has also expanded into pet care, which now accounts for 20 per cent of revenues.

It distributes to hospitals and to part owner the Terry White group.

The company is 40 per cent owned by the Switzerland-based Zuellig family.

Now it gets to show this to the market.

In round terms Sigma’s market share in the wholesale market will fall from 38 to 25 per cent, Cullity’s EBOS will increase share from 30 to 45 per cent, API will stay on around 25 and bits and pieces like CH2 make up the rest.

The challenge facing former mining executive Mark Hooper is where to move next.

His rivals like EBOS and API have already diversified.

The latter took another step down this path last week with the $127.4m acquisition of Clearskincare, which puts it in a strong position in the $1bn market.

API has of course also moved into the challenger retail market through Priceline.

Sigma, which reported underlying earnings before interest and tax last year of $90.7m, is now forecasting earnings this year of $75m and of below $50m next year — less than half of the 2017 returns.

Pharmacy distribution is a tough game, in large part because it is subject to changes in government regulation over the process charges on the PBS list.

This means it must manage constant price deflation.

The average local chemist earns 75 per cent of his or her revenue from prescription drugs, so the PBS terms are vital to their profits.

Hooper downgraded earnings for this year while also disclosing he had lost the key Chemist Warehouse contract from July next year.

The local chemist operates as a key member of health services distribution, providing medical advice as an alternative to the local GP.

This has also enabled it to get special government assistance, with rules governing how many chemists are allowed in a given neighbourhood.

Gance and Verrocchi have, however, shaken that model, raising questions about the viability of the local pharmacist.

The industry maintains that it can actually survive the onslaught because the public trusts the chemists and the industry provides a link in the service delivery chain.

The financial terms of the five-year contract with Chemist Warehouse were not disclosed and while Hooper indicated the terms were not favourable, the business accounts for 40 per cent of its revenues, so it is a big loss.

The company, he said, was now at an inflection point with decisions needed on just where it goes next.

The immediate problem is to overcome the immediate issues that caused the price downgrade and that is all linked to the latest round of PBS price cuts.

Deflation is a perennial issue but the cuts this time around were bigger than most expected and so more trimming is needed at Sigma.

The company is in the middle of a distribution centre expansion, which was based in part on a continuation of the chemist’s warehouse contract from its expiry next June.

Hooper says the unwinding of the contract will free $300m in capital, which in an already strong balance sheet is good news.

But it begs the obvious question: apart from a second-best option like capital management activity, what happens with the funds?

Banker branches out

Marnie Baker’s first day at Bendigo and Adelaide Bank came on the same day her colleague, Rural Bank boss Alexandra Gartmann, was running the royal commission gauntlet.

Of more immediate concern is what plans Baker has for the bank now she has the keys to the boss’s office.

The long-time heir apparent to Mike Hirst, she has spent the last two months free of any hands-on role to give her a chance to work out her strategy.

Hirst has left the bank in good shape but also with questions about where it goes next.

Some investors say Hirst was more worried about customers than shareholders, which says more about the ignorance of those investors, who clearly have their heads firmly in the sand.

But at the same time they are the reality Baker will face.

She has about 3 per cent of deposits, 3 per cent of home mortgages, a strong community bank franchise and no apparent problems in her loan books.

She is awaiting some resolution from APRA about the new capital rules so she can work out whether to push for full accreditation and putting her on the same pedestal as the big four.

Returns on equity of 11 per cent are below the big four thanks to an ill-timed Adelaide Bank merger, but now is not the season to be spruiking higher returns.

The big four are keeping a low profile and following a return-to-their-roots, simple strategy, which is where Bendigo already sits.