UPDATE 2-EU court hurts Celesio expansion plan, shares sink

* EU ruling hits hopes for a German chain

* Court backs German legislation preventing expansion

* UCelesio says ruling provides clarity

* reiterates medium-term outlook

* Stock down 13.3 percent

(Adds comments from CEO, analyst, EU commission)

By Michele Sinner and Ludwig Burger

LUXEMBOURG/FRANKFURT, May 19 (Reuters) - Celesio CLSGn.DE saw its expansion plans for Germany shot down by Europe's highest court on Tuesday when it upheld German legislation preventing non-pharmacists from setting up shop there.

Europe’s biggest drugs distributor has been held back in its domestic market by a law that restricts the ownership of pharmacies to certified dispensing chemists and limits the number of outlets in a drug-retail chain to four.

“The freedom of establishment and free movement of capital do not preclude national legislation which prevents persons not having the status of pharmacists from owning and operating pharmacies,” the European Court of Justice (ECJ) said in a statement.

“Italian and German legislation laying down such a rule is justified by the objective of ensuring that the provision of medicinal products to the public is reliable and of good quality.”

The ruling in line with a recommendation issued by the court’s advocate general, Yves Bot, in December, which at the time sent Celesio’s shares on a one-day slide of 15 percent, from which the stock has not recovered.

Celesio shares again plummeted after the ruling was announced. They were down 13.3 percent at 16.34 euros at 1438 GMT, while Germany's midcap gauge MDAX .MDAX was up 1.7 percent.

“Pharmacy deregulation in Germany was an essential part of Celesio´s ‘equity story’ over the last years. The equity story has vanished now,” DZ Bank analyst Thomas Maul said.

Celesio, which currently makes less than 20 percent of its revenue in Germany, played down the ruling’s significance.

“The takeover of DocMorris was worth it even without liberalisation of the German pharmacy market,” Chief Executive Fritz Oersterle told reporters at Celesio’s headquarters in Stuttgart.

Oersterle said the decision provided it with clarity for planning and he confirmed the company’s 2009 and medium-term outlook.

Celesio, which derives almost half its operating earnings from the UK through its British drug retailer Lloyds Pharmacy, bought Dutch mail-order pharmacy DocMorris in 2007, hoping it would form the nucleus of a chain of drug outlets in Germany and banking on the EU to support its move.

DocMorris then began to open outlets in Germany, in defiance of German regulations, which prompted the country’s pharmacist lobby to press charges in a German court, which then passed the case on to the ECJ.

In anticipation of a EU court ruling in its favour, Celesio expanded DocMorris’s drug mail-order business and sold franchise licenses to pharmacists to get Germans used to the idea of going to a brand-name pharmacy as it prepared to buy pharmacies outright.

Oersterle said DocMorris would continue to sell franchise licenses and increase the number of its pharmacies to 500 by 2011 from 150 now, he said.

A spokesman for the European Commission, which has tried to lift drug-retail restrictions, said the EU’s executive arm would respect the court’s ruling and careful examine it. (Additional reporting by Patricia Gugau in Stuttgart and Dale Hudson in Brussels; editing by Simon Jessop and Karen Foster)