Clicks – if the price was right

15 May 2019

South African listed retailers have been going through a difficult period of late. Not only have the retailers been faced with extremely tough economic conditions, but many retailers have also meaningfully slowed down their space expansion (especially within urban areas), which has been a significant driver of growth in the past.

Within the retail sector, however, pharmacy retail still offers investors strong growth for two main reasons. Firstly, the overall pharmacy retail market is expected to offer attractive growth due to a general affordability trend towards self-medication and generic medicines as well as an increased focus of the mid-higher LSM consumer on health and wellness. Secondly, there is room for further consolidation within the pharmacy retail sector as independent pharmacy retailers still make up a large portion of the market. Due to the size of corporate pharmacy retailers like Clicks and Dis-Chem, and the size of their front shops, they can offer lower dispensing fees which is making it difficult for smaller independents to compete. Leading to corporate pharmacy retailers slowly buying up these stores.

Source: Company Data, Ashburton Investments estimates

But which company’s shares should you buy to gain access to this attractive thematic trend? The star performer within this category has been Clicks. It is a high-quality company with a history of consistent performance and implementation of strategy. Not only has the company performed well within its pharmacy retail stores, it has also built a strong wholesale and distribution business. The wholesale business now generates close to 50% of its revenue from third party clients and achieves a world class operating margin within this space. More recently Clicks’ focus on own brand product has supported margin growth which is a great achievement in the current economic environment.
     

Source: Company Data, Ashburton Investments estimates

So what price should you be prepared to pay for exposure to Clicks? The company is expected to grow between 10-15% over the next few years, however, it trades at an eyewatering 28x 12m forward PE. Dis-Chem, its closest competitor, is expected to grow at 20-25% over the next few years and is trading at a much lower 24x 12m forward PE. Although both companies achieve strong cash flows, a high return on equity and very healthy margins, Dis-Chem has recently demonstrated lower earnings visibility than Clicks after disappointing on earnings expectations twice over the past two years. This is partly because the company experienced two strikes over that period which severely affected performance. Hence, the price discount of Dis-Chem relative to Clicks may be due to the higher perceived execution risk of the former.

Source: Bloomberg, Ashburton Investments estimates

In summary, for factors discussed above, the pharmacy retail market is currently offering good structural growth relative to the overall retail sector in South Africa and is therefore an attractive area for long-term investors. However, Clicks’ current share price looks to be fully pricing in current growth expectations and so investors may want to wait for a better entry point. Further to that, although Dis-Chem is looking attractive on a relative basis, you may want to wait for further clarity on the potential risk of future strikes. In addition to this, an indication of whether a management succession plan is in place may put investors mind at ease.