The Sigma-Chemist Warehouse merger formally completed on 12 February 2025. This report provides our pro-forma updated forecasts and model for the combined entity. We also explore three bull and bear arguments on the stock given its lofty valuation still makes it difficult for us to have anything but a Sell rating.

The ACCC Supermarkets Inquiry report has 20 recommendations. None of these recommendations step change earnings, but the report does highlight three things. Firstly, supermarkets will have more margin volatility in fresh produce; secondly, it provides a reminder that price inflation does lift the industry profit pool; thirdly it will be difficult for Coles and Woolworths to grow market share given limits on new stores and elevated gross margins in some categories.

Harvey Norman reported 1H25 system sales growth of 4% and EBITDA up 4%. Sales trends have improved in absolute terms and relative to market in Australia. The company’s 1H25 result also indicates a better inventory position in Australia, which should support sales and profit margins. While all the key metrics look better for the company, its growth potential is still low in our view and increasingly based on offshore growth.

Lovisa reported 1H25 EBIT of $90 million, up 11%, slightly below consensus estimates of $92 million. With revenue growth stunted by flat comparable sales, gross margin was the standout, hitting a record 82.4% (up 170bp). The trading update signaled an improvement in trading momentum with LFL at 3.7% and the company is confident that the store rollout will reaccelerate. Cost growth gives us pause. Gross margins need to be maintained to offset cost growth if comparable sales don’t deliver, which is difficult with increasing competition. Given the lack of traction in Asia, we have removed the probability of an accelerated China rollout.

Nick Scali delivered a better than expected earnings result and the gross margin recovery since the AGM guidance was a standout. We see 2H gross margin holding flat on last year for ANZ, with group gross margins at 62.3% for FY25e. Initial signs of UK improvement and hints of greenfield expansion has seen confidence grow in the UK rollout. There is, however, now little room for error in execution.

Chemist Warehouse has provided a trading update for the 1H25 results last week subsequent to shareholder approval of the merger with Sigma Healthcare. The 1H25 results are very strong with profit margins up 138bp (on network sales) in 1H25. What’s driving results? While not disclosed, we estimate more than half comes from higher gross margins with a benefit from the new Sigma supply agreement. We expect FY25e EBIT margins to be up 101bp. We now set our long-term EBIT margin for Chemist Warehouse at 8.2% of network sales compared with 7.4% previously. 

We have initiated coverage of Guzman y Gomez (GyG), a fast-food retailer offering Mexican-style cuisine that has exhibited strong like-for-like growth in recent years with a targeted store rollout in the Australian market.  Accelerating store openings combined with margin expansion are the key elements to this growth story. GyG’s Australian store productivity is industry leading and the scope to add more drive-thru stores is substantial. Moreover, fixed cost leverage and higher franchise royalty rates will support a doubling of EBITDA margins over the next four years. 

Lovisa’s AGM trading update revealed weakening sales trends and a slower pace of net new store openings. We expect to see a year of slower store openings, influenced by the CEO transition period being so drawn out. Increasing competition and promotional activity weighs on margins.

The ACCC has approved the merger between Sigma and Chemist Warehouse. We expect the issuance of new shares to Chemist Warehouse will not be until February 2025 at the earliest and could be in March 2025. For a brief period, the stock could have a float-adjusted market cap of $14 billion. By April 2025, the market will increasingly turn its attention to the fundamental earnings and valuation drivers. The most compelling feature is strong revenue growth of circa 10-12%, with more than half from store count growth. The greatest unknown is where sustainable margins settle.

Lovisa has enjoyed a relatively low level of competition. The company has a moat related to the breadth of its frequently refreshed and low-price product offering. How defensive is that moat?  A new entrant in Harli + Harpa, led by ex Lovisa CEO, Shane Fallscheer will launch shortly. Lovisa has derisked its Australian exposure, but its domestic market remains a key funding source for its global expansion aspirations. There are early signs of weakness in Australia and increasing competition will put downward pressure on the highly attractive margins. The global expansion is the key driver of growth for Lovisa but the domestic market still matters.