It was a huge surprise for the market when it was reported Sigma Healthcare Ltd (ASX: SIG) is going to merge with Chemist Warehouse. A key question is how will this affect Wesfarmers Ltd (ASX: WES) shares?
Wesfarmers is best known for its retail businesses of Bunnings, Kmart, Target and Officeworks. But, it also has a sizeable pharmaceutical business with Australian Pharmaceutical Industries (API), which owns various businesses, including Priceline, and it is also a wholesale distributor of pharmaceutical goods.
Bigger competitor to cause problems?
Chemist Warehouse is already the biggest pharmacy business in Australia. It has a multi-national retail network of around 600 stores, mainly operating under the Chemist Warehouse brand.
Sigma recently said it's on track to achieve FY24 earnings before interest and tax (EBIT) of between $26 million and $31 million. Sigma also said in FY23, the Sigma and Chemist Warehouse businesses combined made EBIT of around $500 million. As we can see, Chemist Warehouse is by far the bigger business – it has been equated to being the Bunnings of the pharmacy sector.
Sigma is responsible for Amcal, Discount Drug Stores, Guardian and PharmaSave brands.
This combined business would have a very strong position in the pharmacy and wholesale segments of the market.
It wouldn't surprise me if the ACCC (Australia's competition regulator) had a very good look at this. If the deal were blocked, Wesfarmers shares wouldn't be affected at all.
It's certainly possible that a bigger combined business may be a stronger competitor to Wesfarmers' API. However, there may need to be divestments by Sigma/Chemist Warehouse for the deal to go ahead.
But, even if we assumed that Chemist Warehouse being on the ASX would erase all of Wesfarmers Health's profit, we should remember that the division only made $45 million of earnings in FY23. Wesfarmers made over $2.4 billion of net profit in FY23, so the health division is only a small segment. Plus, Wesfarmers Health includes businesses like InstantScripts and Clear Skincare Clinics which aren't to do with pharmacies.
How Wesfarmers shares could benefit
There are over 5,800 community pharmacies around Australia, with Sigma, Chemist Warehouse and API playing an important role in supplying many of them.
Comments by Jefferies analyst David Stanton may suggest that API's wholesale distribution could benefit if some of those independent operators change which business supplies them. Stanton said:
Independent pharmacies may switch wholesalers at the end of contracts, and in the short term may favour a different pharmacy wholesaler.
We believe there is the potential for loss of independent pharmacists in the medium term who use SIG as a wholesaler, as these pharmacists may not wish to use a combined entity that is a potential retail threat to their business.
Foolish takeaway
Either way, I don't think it's going to impact Wesfarmers shares materially, and there's no guarantee the ACCC will even let it go ahead.
