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Global Equity Research
UBS Investment Research
12-month rating
Jean Coutu Group Inc.
Unchanged
12m price target
C$10.00/US$9.43
Prior: C$10.50/US$9.91
C$8.39/US$7.92
„ EPS was $0.18, in line with expectations; last year was $0.16
Q1 was characterized by weaker than expected sales and better than expected 7 July 2010
margins. Same store sales growth was 2.9% (Rx: 3.8%; FE: 1.0%) vs. UBS at 3.9% (Rx: 4.7%; FE: 2.5%). A soft cough, cold and flu season negatively impacted OTC Trading data (local/US$)
and Rx sales. Sqft. growth was 9%. Pro Doc sales were $30.9 M, up 7% from last 52-wk range C$10.88-8.18/US$10.02-7.69
Q. Pro Doc’s generic version of Lipitor will be available in July. OIBA margin was Market cap. C$1.98bn/US$1.87bn
10.9%, up 46 bps y/y, largely driven by Pro Doc. Shares o/s 236m
Free float 100%
„ Buyback ahead of regulatory change could suggest confidence?
Avg. daily volume ('000) 410
PJC bought back $15 M of its stock in the quarter, which is only a few months in Avg. daily value (m) C$3.7
advance of regulatory change. The implication could be that management does not foresee meaningful disruption to its business model. We continue to calculate that Balance sheet data 02/11E
regulatory change for PJC should be manageable. Shareholders' equity C$0.62bn
„ Potential drug reforms potentially priced in
P/BV (UBS) 1.9x
Assuming a scenario where potential Quebec drug reforms closely match the Net Cash (debt) (C$0.16bn)
proposed Ontario reforms, we estimate a normalized EPS impact of $0.10. We Forecast returns
assume: (1) generic price of 25% of branded from 54% currently (2) 30% Forecast price appreciation +19.2%
reduction in Pro Doc profitability (3) No potential cost-cutting, dispensing fee increases or new service funds (which PJC may benefit from given its royalty Forecast dividend yield 2.7%
structure); also we do not assume a reduction in the royalty rate. Forecast stock return +21.9%
Market return assumption 6.1%
„ Valuation: Maintain Buy rating; price target is $10, down from $10.50
Forecast excess return +15.8%
We value PJC at 11x our blended F12e/F13e EPS. UBS values RAD at US$4, to which we apply a holdco discount. Drug reforms are not reflected in our estimates. EPS (UBS, C$)
Highlights (C$m)
Revenues 2,369.30
02/11E 0.76
EBIT (UBS) 209.30
02/12E 0.81
Net Income (UBS) 140.55
EPS (UBS, C$) 0.58
Performance (C$)
Net DPS (UBS, C$) 0.20
Profitability & Valuation
5-yr hist av.
EBIT margin % 5.3
ROIC (EBIT) % 10.3
EV/EBITDA (core) x 13.7
PE (UBS) x 29.9
Net dividend yield % 0.9
Source: Company accounts, Thomson Reuters, UBS estimates. (UBS) valuations are stated before goodwill-related charges and other adjustments for abnormal and economic items at the analysts' judgement. Valuations: based on an average share price that year, (E): based on a share price of C$8.39 on 06 Jul 2010 19:16 EST [email protected] +1-416-814 3673 This report has been prepared by UBS Securities Canada Inc
ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 8.
UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Jean Coutu Group Inc. 7 July 2010

Good results, all considered
Better than expected margins; lighter than expected sales
PJC’s results were good, all considered. They were characterized by slower than expected sales growth and better than expected margin expansion. Same store sales growth was 2.9% (Rx: 3.8%; FE: 1.0%) vs. UBS at 3.9% (Rx: 4.7%; FE: 2.5%). Square footage growth in the quarter was 9%. Rx growth, in the context of historical trend, was poor. The average Rx same store sales growth over the last 3-years has been 6.2% with a stable trend. Management largely attributes the soft Rx trends in the current quarter to a weak cough, cold and flu season. Front end sales were also impacted from weak cough, cold and flu related sales, chiefly in the OTC category. We note that the Canadian Public Agency of Health stated that “overall influenza activity has remained low since the beginning of 2010”. We are not concerned with soft Q1 sales trends - management stated that PJC continues to gain market share implying a continued strong competitive position. We will look for soft cough, cold and flu trends to extend to SC’s results. PJC’s OIBA margin was 10.9%, versus 10.7% expected and last year at 10.4%. Pro Doc was the chief driver of higher margins, as it has been for over one year. Management reiterated its focus on square footage growth, which should be ~8-9% this fiscal year. Continued square footage growth should support sales trends for the foreseeable future (as a reference, recall that SC moderated its real estate growth expectations following the Ontario government’s release of drug reforms). We remind investors that PJC’s business model and profitability drivers are different than SC’s. Accordingly, we believe PJC’s economics are more insulated from regulatory change than SC’s – we note the following: (1) PJC has 12% of its equity value in Rite Aid (2) PJC is located principally in Quebec, which eliminates the overhang associated with potential drug reform in other provinces (3) PJC is a franchisor and is not directly exposed to the key profitability issue of professional allowances (although royalty rates may be moderately reduced). Potential drug reforms, potentially priced in
Assuming a scenario where potential Quebec generic drug price reductions mimic the Ontario reforms, we estimate a normalized EPS impact of $0.10. This would result in F11 EPS of $0.65 versus our current unadjusted 12-month forward EPS estimates of $0.75.1 Our estimated $0.10 EPS drain associated with Quebec drug reform assumes: (1) 54% reduction in gross profit on generic drugs (2) 30% reduction in Pro Doc profitability (3) no potential cost-cutting, dispensing fee increases or new 1 We provide a normalized EPS impact so investors can isolate PJC’s operating performance under the new regulatory regime. In actuality, there could be a graduated implementation of drug reforms.
Jean Coutu Group Inc. 7 July 2010
service funds (which PJC may benefit from given its royalty structure); we also do not assume a potential reduction in the PJC’s franchise fee. Follow the cash
PJC’s activity in the buyback is significant to us as it provides an indication on management’s view of the outlook. Ultimately, we are not privy to the discussions between the Quebec government and the various generic drug stakeholders – this introduces uncertainty in our outlook. Given that PJC management has access to the most information, including confidential stakeholder meetings, its use of cash amid pending regulatory change is meaningful. Furthermore, in highly uncertain situations, such as the one we are presented with, we think it is more important to follow the cash versus the political and industry rhetoric. Some investors may argue that PJC’s share buyback is a reflection of a strategic
void more than an indication of value/outlook. This is a debatable point - but
even if we were to assume that there was a strategic void, it is still logical for us
to believe that management would have waited a few months before buying
back stock if it expected significant financial impairment as a result of
regulatory change.
(Management purchased 1.7 million shares during Q1/F11 for a total consideration of $15 million. The buyback program allows for up to 11.1 million shares.) Soothing sentences
Managements comments on regulatory reform during the conference call were viewed as constructive by many investors - this helped to drive the stock up 2.6%, post the conference call. As a recap, the Quebec government will reduce generic drug prices to 25% of the branded equivalent from ~54% currently. Implementation will be delayed for 4 to 8 weeks as the Quebec government meets with stakeholders to discuss transition. The next meeting between the Quebec government and stakeholders will be held in early August. PJC management implied that the discussions with the Quebec government have been more collaborative than those that took place with the Ontario government. Management also stated that the Quebec government might not look to eliminate professional allowances because the system is already “transparent”. We note that the Quebec governments’ apparent collaborative tone could be political posturing… as it was in Ontario. PJC management has publically stated that lower generic drug prices should be augmented with measures to assist market participants with the transition to lower generic drug prices. Maintain Buy rating

Jean Coutu Group Inc. 7 July 2010
We maintain our Buy rating; our price target goes to $10 from $10.5, largely reflecting declines in the value of RAD. Our price target is premised on 11x our blended F11/F12 EPS estimate of $0.78, plus the equity value of RAD, to which we apply a holdco discount. Our financial estimates remain largely unchanged, as we have not incorporated changes to Quebec’s drug pricing regime. Our PJC valuation multiple of 11x EPS reflects uncertainty associated with projections – we believe PJC’s normalized EPS multiple is in excess of 12x. Table 1: Target derivation
Blended F12/F13 PJC EPS $0.78
Canadian operations valuation multiple: 11x $8.19
UBS RAD price target (USD) $4.00
UBS RAD price target after holdco discount (USD) 2 $1.72
USD to CAD F/X of 1.05x $1.81
RAD value per PJC share
PJC 1-year target price $10.14
We believe PJC’s stock should be ~$9 today – we use our pro forma forward EPS of $0.65, and RAD at current market prices, with a 20% holdco discount. The worst case on regulatory reform
Assuming a worst-case scenario where generic drug prices are cut to 25% of the reference branded price and Pro Doc is disallowed, we estimate a normalized EPS impact of $0.17. We do not view this outcome to be likely. As it stands, we believe our $0.10 EPS estimate of potential profitability drain is aggressive. In our view, a 54% reduction in generic drug profitability is unlikely as dispensing fees will likely remain untouched (Ontario has not established a precedent for lower dispensing fees, in fact, dispensing fees were moderately increased). Dispensing fees are a critical component of PJC’s profitability in generic drugs. To provide some context - in F11, under the status quo regulatory environment, we estimate that $15 million of PJC’s gross profit will be generated from the mark-up on generic drugs; $12 million will be from the royalty on the dispensing fee; and $9 million will be from the royalty on the drug cost (excl. the dispensing fee). The point being, if generic drug prices were slashed, the royalty on dispensing fees would remain, and so, PJC’s profitability erosion would not be linear with the price cut, as we presently assume. However, at this point, we will maintain our estimates in the interest of conservatism. Attached below is a detailed breakdown of how we arrive at our $0.10 impact to EPS. 2 Our holdco discount effectively also equates to the consensus 1 year RAD price target with a 20% discount. (The Thompson Financial 1-year price target on RAD is $2.15.)
Jean Coutu Group Inc. 7 July 2010
Table 2: Potential EPS hit from Quebec regulatory changes
Generic drug prices cut to 25% of brand from 54%
Royalty on dispensing fees 0.02
Royalty on the drug price (ex. dispensing) 0.01
Pro Doc profitability 0.04
Potential normalized EPS hit 0.10
Jean Coutu Group Inc.
Income statement (C$m)
% ch
% ch
% ch
Revenues
11,146.90
11,679.50
1,676.30
2,369.30
2,543.10
2,638.65
2,719.09
2,862.33
Operating expenses (ex depn)
EBITDA (UBS)
Depreciation
Operating income (EBIT, UBS)
Other income & associates
Net interest
Abnormal items (pre-tax)
Profit before tax
Profit after tax
Abnormal items (post-tax)
Minorities / pref dividends
Net income (local GAAP)
Net Income (UBS)
Tax rate (%)
Pre-abnormal tax rate (%)
Per share (C$)
% ch
% ch
% ch
EPS (local GAAP)
EPS (UBS)
Balance sheet (C$m)
% ch
% ch
% ch
Cash and equivalents
Other current assets
Total current assets
2,500.00
Net tangible fixed assets
Net intangible fixed assets
Investments / other assets
Total assets
5,591.00
2,208.20
1,949.30
1,014.40
1,057.00
1,187.19
1,325.94
Trade payables & other ST liabilities
Short term debt
Total current liabilities
1,306.20
Long term debt
Other long term liabilities
Total liabilities
4,025.30
Equity & minority interests
Total liabilities & equity
5,591.00
2,208.20
1,949.30
1,014.40
1,057.00
1,187.19
1,325.94
Cash flow (C$m)
% ch
% ch
% ch
Net income
Depreciation
Net change in working capital
Other (operating)
Net cash from operations
Capital expenditure
Net (acquisitions) / disposals
Other changes in investments
Cash from investing activities
2,179.50
(143.10)
(117.10)
Increase/(decrease) in debt
Share issues / (repurchases)
Dividends paid
Other cash from financing
Cash from financing activities
(206.70)
(2,405.50)
(115.00)
Cash flow chge in cash & equivalents
FX / non cash items
Bal sheet chge in cash & equivalents
Core EBITDA
Maintenance capital expenditure
Maintenance net working capital
Operating free cash flow, pre-tax
Source: Company accounts, UBS estimates. (UBS) valuations are stated before goodwill-related charges and other adjustments for abnormal and economic items at the analysts' judgement. Note: For some companies, the data represents an extract of the ful company accounts. Global Equity Research
Jean Coutu Group Inc.
P/E (local GAAP)
P/E (UBS)
Company profile
Net dividend yield (%)
The Jean Coutu Group is the 2nd largest pharmacy chain in Canada EV/revenue (core)
and the first in Québec. Company operations are based on a EV/EBITDA (core)
franchise model, as under Quebec law only pharmacists are EV/EBIT (core)
permit ed to own a pharmacy. PJC franchisees own their businesses EV/OpFCF (core)
independently from The Jean Coutu Group and, as a result, are EV/op. invested capital
responsible for managing their franchised stores and for funding their investments in inventory and store fixtures. The company chiefly generates revenues from royalties, based on a percentage of store Average market cap
sales, and from the sale of merchandise to franchisees from its + minority interests
+ average net debt (cash)
+ pension obligations and other
- non-core asset value
Core enterprise value
Value (EV/OpFCF & P/E)
EBITDA (UBS)
EBIT (UBS)
EPS (UBS)
EBITDA / revenue
EBIT / revenue
Profitability
Net profit (UBS) / revenue
EBIT ROIC (UBS)
ROIC post tax
EBIT / net interest
Dividend cover (UBS EPS)
Div. payout ratio (%, UBS EPS)
Net debt / EBITDA
ROE v Price to book value
Revenue / op. invested capital
Revenue / fixed assets
Revenue / net working capital
OpFCF / EBIT
Capex / revenue (%)
Capex / depreciation
Growth (UBS EPS)
Net debt / total equity
Net debt / (net debt + equity)
Net debt (core) / EV
Source: Company accounts, UBS estimates. (UBS) valuations are stated before goodwill-related charges and other adjustments for abnormal and economic items at the analysts' judgement. Valuations: based on an average share price that year, (E): based on a share price of C$8.39 on 06 Jul 2010 19:16 EST Market cap(E) may include forecast Analyst [email protected] +1-416-814 3673
Jean Coutu Group Inc. 7 July 2010
Q Jean Coutu Group Inc.
The Jean Coutu Group is the 2nd largest pharmacy chain in Canada and the first in Québec. Company operations are based on a franchise model, as under Quebec law only pharmacists are permitted to own a pharmacy. PJC franchisees own their businesses independently from The Jean Coutu Group and, as a result, are responsible for managing their franchised stores and for funding their investments in inventory and store fixtures. The company chiefly generates revenues from royalties, based on a percentage of store sales, and from the sale of merchandise to franchisees from its distribution centers. Q Statement of Risk
As a retailer Jean Coutu Group is susceptible to a downturn in consumer activity. Jean Coutu faces several competitors in all regions in which it operates, some of whom have greater resources, greater capital, and greater geographic diversification. Barriers to entry into the industry are low, and a significant new competitor could enter the marketplace virtually at any time. Prescription retail pricing is a heavily regulated industry in the regions in which Jean Coutu operates. Divisions by governments, insurers, and other regulatory bodies - which may or may not be driven by economic events - could have material impact on the operating performance of Jean Coutu. In addition to general industry factors, additional risks at Jean Coutu include the company's concentrated geographic exposure in the province of Quebec. Jean Coutu also has significant operations in the United States and may at time be exposed to significant fluctuations in the currency exchange rate. Jean Coutu's management has also indicated interest in making additional acquisitions. An acquisition would entail pricing, execution and integration risks for the company over a prolonged period. An acquisition of significant size might materially burden the company's financial resources. Q Analyst Certification
Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.
Jean Coutu Group Inc. 7 July 2010
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Jean Coutu Group Inc. 7 July 2010
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Company Disclosures
Company Name
12-mo rating Short-term rating
Price date
Jean Coutu Group Inc.
Rite Aid Corp.16
Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 16. UBS Securities LLC makes a market in the securities and/or ADRs of this company. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.
Jean Coutu Group Inc. 7 July 2010
Jean Coutu Group Inc. (C$)

Rite Aid Corp. (US$)
Note: On August 4, 2007 UBS revised its rating system. (See 'UBS Investment Research: Global Equity Rating Definitions' table for details). From September 9, 2006 through August 3, 2007 the UBS ratings and their definitions were: Buy 1 = FSR is > 6% above the MRA, higher degree of predictability; Buy 2 = FSR is > 6% above the MRA, lower degree of predictability; Neutral 1 = FSR is between -6% and 6% of the MRA, higher degree of predictability; Neutral 2 = FSR is between -6% and 6% of the MRA, lower degree of predictability; Reduce 1 = FSR is > 6% below the MRA, higher degree of predictability; Reduce 2 = FSR is > 6% below the MRA, lower degree of predictability. The predictability level indicates an analyst's conviction in the FSR. A predictability level of '1' means that the analyst's estimate of FSR is in the middle of a narrower, or smaller, range of possibilities. A predictability level of '2' means that the analyst's estimate of FSR is in the middle of a broader, or larger, range of possibilities. From October 13, 2003 through September 8, 2006 the percentage band criteria used in the rating system was 10%.
Jean Coutu Group Inc. 7 July 2010
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