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
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 theCanadian 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.)
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
and the first in Québec. Company operations are based on a
franchise model, as under Quebec law only pharmacists are
permit ed to own a pharmacy. PJC franchisees own their businesses
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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UBS Investment Research: Global Equity Rating Allocations UBS 12-Month Rating Rating Category Coverage1 IB Services2 Hold/Neutral UBS Short-Term Rating Rating Category Coverage3 IB Services4
1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS. Rating allocations are as of 30 June 2010.
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because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned
because of a specific catalyst or event.
Jean Coutu Group Inc. 7 July 2010 KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.
Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows.
UBS Securities Canada Inc: Vishal Shreedhar.
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 Global Disclaimer
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Material Safety Data Sheet Date Prepared: 10/17/03 X-Gen Pharmaceuticals Prepared Technical Assistance: 607-562-2700 Big Flats, NY 14814 TRIAMCINOLONE ACETONIDE IDENTIFICATION Common Name: Triamcinolone Acetonide Chemical Name: Pregna-1,4-diene-3,20-dione, 9-fluoro-11,21-dihydroxy-16,17-[(1- methylethylidene)bis(oxy)]-, (11beta, 16alph