Dis-Chem: my pick in the sector

Dis-Chem is my pick of the litter in the retail pharmacy sector on the JSE. Admittedly, that litter only has two kittens in it and both are expensive. Clicks and Dis-Chem trade at multiples that leave many scratching their heads. My suspicion is that Dis-Chem will outperform Clicks over the next 12 – 18 months, but time will tell. Importantly, “outperform” shouldn’t be interpreted as “will perform well” as both are at lofty multiples.

In the year to February 2022, Dis-Chem posted revenue growth of 15.7%. Headline earnings per share (HEPS) is up 27.6% to 99.2 cents and the total dividend per share is up 27.6% as well.

Like its arch-rival Clicks, Dis-Chem was a beneficiary of the Covid vaccine program. 1.4 million doses were administered, contributing R513 million in revenue. On a prior-year revenue base of R26.3 billion, that’s a 2% revenue uplift that I sincerely hope won’t be there in the coming year. I’m rather sick of pandemics, if you’ll excuse the pun.

Unlike that same arch-rival, Dis-Chem is strongly weighted towards its retail business rather than the wholesale sector. Retail revenue was R27.1 billion of the group total of R30.4 billion, or 89% of group revenue. It grew by 15.6% which includes the impact of acquisitions.

The retail margin improved from 27.5% to 28.2% as the group experienced a normalisation in the sales mix. This is critical, as higher margin categories in the “front shop” needed to recover. Pharmacy groups don’t make their money behind the medicine counter.

The wholesale business grew by 13.7%, with a particularly interesting 25.2% increase in external revenue to The Local Choice franchises, which increased in number from 122 to 147. Sales to independent pharmacies grew by 10.9% or 14.8% if you exclude once-offs in the base. The wholesale margin was 7.5%.

Expenses grew by 17.3% overall and 15.2% if you exclude the Medicare cost base as a major acquisition. Retail expense growth of 15.4% (excluding Medicare) included investment in pharmacists and clinic sisters to facilitate the vaccine program. Wholesale expenses excluding depreciation grew by 8.7%, a surprisingly low amount relative to revenue at a time when inflationary cost pressures have been evident. I would caution here that this reporting period ended in February, with most of the fuel price pain coming from March onwards.

With a focus on return on invested capital (ROIC) and related working capital efficiencies (net working capital cash inflow of R45 million despite the growth in the business), net financing costs fell by 29.7% excluding the impact of IFRS 16, the world’s stupidest accounting standard that treats lease payments as interest. Of course, a reduction in interest rates also helped.

Capital expenditure was R377 million, of which R237 million was expansionary expenditure and R140 million was maintenance expenditure.

Revenue growth has accelerated since the end of this period, up 16.1% year-on-year for the 1 March to 16 May trading period. In my view, Dis-Chem has a number of exciting growth drivers (Baby City, medical insurance and wholesale market penetration to name a few) and is one to watch. With a Price/Earnings multiple of 34.6x though, I personally am not buying the shares at this price. If the multiple doesn’t unwind though, it could offer strong returns.

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