Ebos, which is listed on both the Australian and New Zealand stock exchanges and is currently the supplier for the TerryWhite Chemmart pharmacy chain, estimates the new contract will generate around $1 billion in wholesale sales in its first year. Founded in 1995 by Mario Verrochi and Jack Gance, the Chemist Warehouse Group has expanded rapidly on a business platform established in 2002 after the acquisition of an entity called East Yarra Friendly Society. With sales exceeding $4.5 billion, Chemist Warehouse is the seventh largest retail company in Australia and excluding the German-owned Aldi supermarkets, the pharmacy chain is the largest retailer in private ownership. After the announcement last week of the Chemist Warehouse contract negotiation outcome, Sigma’s share price plunged below 50 cents, less than half its quotation on the Australian Stock Exchange in January. Heavy selling of scrip by Sigma shareholders reflected concern about the revenue and earnings impact on the wholesaler, from the loss of the market leading pharmacy brand. Wholesale dominance over Just as the grocery wholesaler Metcash will be severely weakened by the loss of around 50 Drakes Supermarkets stores in South Australia at the end of the current financial year, Sigma arguably faces a bigger challenge to stabilise its business after losing a significantly more important retail customer in Chemist Warehouse. The days of the dominant wholesalers are long gone and although both Metcash and Sigma have some financial security as public companies listed on the Australian Stock Exchange, they are vulnerable to defections from their larger retail customers. The defections involve more damage to the wholesalers than the direct loss of sales and earnings of the departing independent chains as they reduce buying power and marketing clout. The defections of large customers also inflate administrative and operational costs, including critical logistics costs and retail support programs because they need to be amortised over a smaller number and, in many cases, a less productive number of stores. Increased costs to a wholesaler’s remaining customers can realistically lead to further departures as independent retailers strive to be competitive with chains. The Drakes Supermarkets decision to establish its own warehouse in Adelaide and not to renew its supply contract with Metcash in June next year has left the grocery wholesaler potentially vulnerable to the defection of other groups, such as the former Foodland stores in South Australia and the Ritchies IGA chain. Sigma owns and controls the Amcal and Guardian retail banners but could well see individual stores and groups targeted by Australian Pharmaceutical Industries with its Priceline franchise, TerryWhite Chemmart or even Chemist Warehouse. The immediate impact of the Chemist Warehouse contract termination in June next year leaves Sigma with a market share estimated by IBISWorld of 19.3 per cent, with revenues largely derived from five key brands, Amcal, Guardian, Chemist King, Discount Drug Stores and PharmaSave. Sigma’s market share currently is close to double the TerryWhite Group and API’s Priceline, each with around 10.2 percent according to IBISWorld, a leading business analyst firm. IBISWorld estimates the TerryWhite Group has a 10.2 percent share of the retail pharmacy market, after its 2016 merger with the Chemmart chain that now has most of its 500 pharmacies trading under the TerryWhite Chemmart banner. API, the fourth major player in retail pharmacy, owns the Priceline Pharmacy banner and also suppliers Soul Pattinson Chemist, Pharmacist Advice, Pharmacy Best Buys and independent pharmacies. On the face of it, Sigma has the market share to withstand competitive forays by TerryWhite Chemmart and its wholesaler Ebos and API headlined by Priceline Pharmacy, but it faces a significant challenge next financial year to maintain, let alone, increase growth. Clearer path In a release to the Australian Stock Exchange last week, Mark Hooper, Sigma CEO, said discussions between the wholesaler and the Chemist Warehouse Group had been ongoing since early this year but had reached the stage where the proposed terms for a contract extension could not be agreed. Hooper, said Sigma made it clear at the start of the negotiations that it would only enter into a new contract if it made commercial sense and provided an adequate return on invested capital.   Hooper said the wholesaler was not prepared to risk significant shareholder funds without adequate and sustainable returns. “Importantly for Sigma, this decision provides a clearer future and a runway to make the required changes to re-shape the operating and fixed cost base of our business,” he said.   “Over $300 million cash will be freed up at the conclusion of the contract which will enable us to expedite the execution of our strategy to diversify and strengthen our business with a broader healthcare focus.” While bullish on the future and pointing out that Sigma will continue to supply the Chemist Warehouse Group under the terms of the existing supply agreement until June 30 next year, Hooper cautioned on trading expectations for the current financial year. Hooper said Sigma was revising its earnings forecast down from $90 million to around $75m for the current financial year due to a continuation of soft trading conditions in May and June along with a more significant impact from the introduction of the June PBS price adjustment than had been expected. The wholesaler estimates its earnings before interest and tax for financial year 2020 will be down to between $40 million and $50m based on current known factors, including the Chemist Warehouse exit. Hooper said Sigma is focusing on reducing operating costs and will boost its balance sheet with a $300 million-plus provision related to the Chemist Warehouse supply contract in FY20. “The medium term strategy will be to focus on further cost reductions in the business, structural rationalisation of the Sigma distribution centre network and targeted sales opportunities including hospitals,” said Hooper. “Obviously the return of significant funds to Sigma [$300 million] also enhances our ability to look at other merger and acquisition opportunities in the short to medium-term that fit our strategic direction and deliver the same or better return metrics.” The decision on the Chemist Warehouse Group contract, Hooper affirmed, creates an important pivot point for Sigma.   “It may be a step back in our short-term financial results, but it 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,” he said. The medium-term target, according to Hooper, is to put Sigma in a position where earnings will be at the same level as if it had retained the Chemist Warehouse Group contract on the terms proposed, but with the added benefit of the release of $300 million of funding and a substantially de-risked business. The relationship between Sigma and the Chemist Warehouse Group has had some awkward moments, particularly when the struggling 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 relationship was again strained last year when the wholesaler initiated and subsequently withdrew legal action against Chemist Warehouse over supply arrangements the retail group attempted to pursue outside an existing contract. The Chemist Warehouse Group mulled over a prospective float on the Australian Stock Exchange last year, an option that might yet be pursued by the retailer notwithstanding the complexities of an ownership structure developed to address national pharmacy ownership restrictions.