UPDATE 1-Japan's 'Matsukiyo' in merger talks to create drugstore giant

* Combined sales forecast exceed 1 trln yen

* Cocokara had also considered tie-up with Sugi Holdings

* “Matsukiyo” pioneered drugstore sales of discount cosmetics

* (Updates with company confirmation, adds industry background)

TOKYO, Aug 14 (Reuters) - Japanese drugstore giant MatsumotoKiyoshi Holdings said it was starting talks to merge with rival Cocokara Fine Inc, possibly creating the country’s biggest chain of discount pharmacies with nearly $10 billion in annual sales.

Cocokara Fine shares briefly jumped 9% on Wednesday after the company said it had decided to negotiate a potential merger with the bigger MatsumotoKiyoshi. It had considered a tie-up with another drugstore chain, Sugi Holdings, but chose an offer from MatsumotoKiyoshi instead, it said in a statement.

The companies said they could not comment on details of negotiations, such as possible terms and deadlines for the talks.

Known as “Matsukiyo”, MatsumotoKiyoshi started as a mom-and-pop pharmacy in the 1930s and has grown rapidly through aggressive store openings and acquisitions. It was a pioneer in drugstores’ sales of discount cosmetics, allowing consumers to more casually sample products.

It and other major drugstores have also expanded into snacks, soft drinks, and liquor, dealing a blow to the country’s convenience stores and supermarkets. But drugstores, like the rest of Japan’s retail industry, are now grappling with a dwindling workforce and tough price competition.

“It will not be easy to overcome business challenges on our own, and therefore it is appropriate for us to merge,” Cocokara said in a statement.

“By combining with MatsumotoKiyoshi Holdings ... there is a chance of creating major synergies such as improving work efficiency and developing private brand products.”

A merged company will earn over 1 trillion yen ($9.4 billion) in annual sales, topping sector leaders Welcia Holdings and Tsuruha Holdings.

Shares in Cocokara Fine surged to their highest since November 2018, and were up 1.3% in mid-afternoon trade, while MatsumotoKiyoshi shares fell 2%.

Shares in Sugi, which said it would look for other potential partners, rose around 2%.

$1 = 106.2900 yen Reporting by Ritsuko Ando; Editing by Muralikumar Anantharaman and Stephen Coates