Clicks is struggling in wholesale

The Clicks share price is flat this year, so it’s been a much better investment than the US tech companies that the market got too excited about in 2021. Like those companies, Clicks trades on a substantial multiple.

The market sees this as a defensive stock, which I’ve always found a little odd as the model has significant reliance on selling small appliances in the so-called “front shop” – the part of the store unrelated to the dispensary. Margins on pharmaceuticals are regulated and aren’t terrible exciting, so the magic for shareholders happens between the pharmacist and the queue in the front of the store.

If I look at the pain and agony inflicted on Massmart shareholders by a disruptor like Takealot, it’s not obvious to me why the small appliances business at Clicks won’t face the same pressures. Only time will tell.

In the latest period, Clicks’ turnover from continuing operations only increased by 9%. This was good enough to increase continuing diluted HEPS by 20.1% and the interim dividend by 26.3% to 180 cents per share.

If you adjust for the second SASRIA insurance payment, diluted HEPS from continuing operations only grew by 10.2%.

The reason for reporting results from continuing operations is that Musica was closed in May 2021. That business is therefore in the base, so Clicks effectively excludes it to give a meaningful comparison.

The Covid-19 vaccination programme has been great for Clicks, with the store network helping with a national roll-out of vaccines. The group has administered over 3 million vaccinations since the start of the programme.

As we dig deeper into the turnover number, we find that retail sales grew by 13.6% and distribution turnover only increased by 0.6%. I would interpret this as the effect of the vaccinations, as that would be captured in the retail sales but not in the distribution sales. I can’t think of another reason why the difference would be so large.

Vaccinating people is a low margin business, so retail margin was negatively impacted by 40bps. Distribution margin increased by 20bps despite the low revenue growth.

Retail costs grew by a substantial 12.2% due to growth in the business, with costs on a like-for-like basis increasing by 6.5%. The impact of inflation is clear.

Margin pressure in UPD is becoming a real issue. Distribution costs increased by 8.4% based on higher fuel, security, insurance and electricity costs. Compared to practically no growth in distribution revenue, that’s a proper headache for management that might take more than over-the-counter pills to cure.

The overall impact on margins is a 20bps decrease in group adjusted operating margin to 7.8%.

On the plus side, inventory days decreased which means that less cash was tied up in stock. Cash generated from operations was R590 million and capital expenditure was R352 million, considerably higher than R269 million in the comparable period.

Share buybacks were R446 million and dividends of R848 million were paid. At period end, the group held cash resources of R838 million.

The second half of the year will be supported by a further 28 stores being opened. Although the vaccination programme is ongoing, I suspect that the bulk of the revenue from that initiative has already been made.

The biggest risk in my eyes is UPD, the wholesale business. Clicks notes that normalised activity (including at hospitals) will be positive for UPD’s customers. Shareholders will certainly hope that this will be the case!

With a planned capital expenditure bill of R876 million for the full year, shareholders should pay close attention to the level of free cash flows in the business. Return on equity of 47.2% is excellent and means that the company generates economic profits by investing shareholder capital, but the focus should actually be on return on incremental invested capital, a number that very few companies ever report. It’s worth doing some research on the concept if you are serious about your investing.

Clicks expects diluted adjusted HEPS from continuing operations for the year to be between 8% and 13% higher than in FY21. This implies a level between 904 cents and 946 cents.

With a share price of R320, this is a forward Price/Earnings multiple of around 35x

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