In this week’s update, we delve into insights regarding ParagonCare’s recent strategic movements.
Read the previous week’s Investment Matters.
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ParagonCare (PGC) has been a long-held position in clients’ Australian equities sub-portfolios. First Samuel clients are collectively one of the largest institutional shareholders of the company.
The Market
What does ParagonCare do?
ParagonCare is a leading provider of equipment, devices and consumables to the healthcare market.
It is organised across four strategic divisions:
- Specialty Diagnostics: providing solutions to Immunohematology, Diagnostic and Scientific Laboratories. Within this division exists the Immulab business, which designs, manufactures and distributes Reagent Red Blood Cells. This was a business that originated within CSL.
- Speciality Devices: making equipment for Eye Care and Orthopaedic practitioners, including theatre lighting and replacement joints.
- Capital and Consumables: includes surgical airway masks and defibrillators.
- Services and Technology: addresses maintenance requirements for machinery used for medical scans
Merger with Clifford Hallam Healthcare (CH2) – a big reset
In June 2024, ParagonCare completed a merger with Clifford Hallam Healthcare (CH2). This effectively involved a reverse takeover by CH2 management and board. CH2’s David Collins appointed Group CEO and Peter Lacaze appointed as Chairman of the Board. CH2 represented 57% of the merged entity at the time of the deal.
Clifford Hallam Healthcare (CH2) is a leading national integrated pharmaceutical, nutritional, medical consumables and complementary medicines provider. The merger provided PGC with synergies in personnel, occupancy costs as well as improvements in the cost of finance and a broadening of distribution opportunities. Enunciated cost savings of $5m seemed easily achievable from the opportunities in trimming leasing costs alone.
Figure 1: Paragon and CH2 addressable market
Source: Company reports
We were encouraged with the emergence of unlisted CH2 as a suitor for PGC. We felt that new CEO David Collins would bring improved disciplines to the PGC business, which had appeared to struggle to develop a coherent strategy as well as have the necessary execution and expense disciplines in place to generate the cashflow we look for in portfolio companies. Additionally, the company was increasingly irrelevant to ASX investors because of its size and (il)liquidity.
Our optimism has proven well-founded, with a corresponding rebound in the share price (up 21% in the past 12 months), which had been in the doldrums for several years in the absence of the necessary leadership and scale.
Sigma and Chemist Warehouse merger – an additional opportunity
In addition to merger synergies, a changing industry landscape also provides opportunities for PGC to win market share.
Similar to the merger of Clifford Hallam Healthcare (CH2) and PGC, ASX-listed Sigma Healthcare, a major competitor of CH2, has also recently combined with a larger privately-owned organisation. This merger combination with Chemist Warehouse has created the largest retail pharmacy franchisor, wholesaler and distributor in Australia and will be a formidable competitor to the new PGC.
Still, given the Sigma Group will have 15% market share of pharmacy franchises in Australia (think Chemist Warehouse, Amcal, Discount Drug Stores and Guardian) the large share of the market still remaining in the hands of (often) ‘fiercely’ independent pharmacists may be resistant to sourcing supplies from an entity that is aligned with its largest competitors. Sigma has $700m of revenue from independent pharmacy businesses alone, which now becomes more contestable for PGC/CH2 given the shift in ownership.
In addition to Sigma, ParagonCare/CH2’s largest competitors in pharmacy wholesaling are EBOS (12% share, with brands including Terry White Chemmart) and API (Wesfarmers-owned Priceline) that have their own prominent pharmacy brands, leaving PCG/CH2’s uniquely placed as a non-aligned pharmacy wholesaler.
Figure 2: Chemist Warehouse/Sigma pharmacies will have 15% market share
Source: Company data, Macquarie Research
Recent interim results – Pharmacy division strength
Figure 3: 1H25 Revenue growth underpinned by the larger pharmacy business
Source: Company reports
The recent interim results of ParagonCare tells a tale or two.
The pharmacy supply business of the former Clifford Hallum Healthcare business, the largest source of Group revenue (representing almost 80% of Group revenue in the half), continues to win share and grow revenues at a double-digit clip. Specifically, within this division, the former CH2 business grew revenue by 30% against in industry backdrop of 8.7%.
Other business lines, particularly those directly servicing the hospital sector, tended to be much more subdued given the challenging nature of profitability for hospital operators at present (think Healthscope).
Figure 4: Profit and Loss
Source: Company reports
However, as this pharmacy business is also at much finer margins, this had a deleterious impact on Gross margins.
Encouragingly, the $5m of enunciated synergies expected from the merger at the time of initial announcement has now been upgraded to $12m in FY26, helping to underpin earnings growth over the medium-term as operating margins should improve.
Figure 5: Cashflow and Balance Sheet- a lift in debt and decline in returns
Source: Company reports
The changing nature of the business towards being an everyday supplier to pharmacies and hospitals has seen a changing nature of the Group’s balance sheet and cashflow along with it.
As the newly appointed Group CFO, Marcus Crowe, reminded us in a meeting in March, pharmacists are unable to maintain their license if they trade while bankrupt and therefore they tend to maintain a very conservative approach to managing their finances, making them very good payers. Hospitals too are very good payers but with daily demand for supplies, they do not pay on a direct debit basis like other industries operate.
This means CH2’s primary financier ScotPac offers unique terms to PGC/CH2 that accounts for significant variances in the supply of goods and cash flow of up to $20-30m in any day. With the need for high group inventory levels of $300m to be carried and stock turning over up to 12 times per year, the velocity and variance of cashflows is immense in this business.
So, while the increase in absolute debt outstanding was significant as the business has grown and the CH2 business became more predominant within the PGC stable of businesses, we don’t consider this increase in ‘revolving’ debt to be problematic. We think that some investors in the stock became a little spooked by rising debt levels. We’re comfortable with the balance sheet structure being employed by ParagonCare.
Summary
The ParagonCare business is one of few longstanding, legacy portfolio positions that remain in clients’ portfolios. Our expectation that the assets of the business could yield better returns for shareholders under a new management team is being confirmed. Thankfully, the patience we have exhibited is being rewarded and the competitive position of the business slowly improved.
The business is in fundamentally better shape with a bigger balance sheet, has been newly presented with a sizeable market share growth opportunity to pursue and has a better management team at the helm. This points to improved prospects for shareholders.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.