There has long been concern about the unflinching premium rating investors attach to health and beauty retailer Clicks. A recent dip in the group’s share price has fuelled debate about whether the priced-for-perfection rating — a historic earnings multiple of about 30 — is justified and sustainable.
Clicks’s heady valuation reflects its strong market position, consistent financial performance, defensive characteristics and growth potential. Investors (many from overseas, given a 59% foreign share ownership) view it as a quality stock that can deliver returns in stable and challenging economic conditions.
But the shares fell 3.7% when the group released a trading update recently pointing to weaker than expected group turnover and retail sales, though volumes and market share grew. Comparable store sales slowed to 5.9% from 8.4% in the 20 weeks to January 12. Volumes grew 2.4%.
Performance was weighed by the temporary delay in issuing pharmacy licences while Clicks waits for the sale of its medicine manufacturing business, Unicorn Pharmaceuticals. There was stronger growth in promotional sales than in nonpromotional sales, and turnover was up 9.5% at wholesaler United Pharmaceutical Distributors (an improvement from the drop of 0.8% in the comparable period).
Damon Buss, senior equity analyst at M&G Investments, says both Clicks and rival Dis-Chem are expensive. “The quality of Clicks warrants a premium to the market and retail peers. However, the current relative differential is too wide, in our opinion.”
The metrics … the operating margins, the cash generation, the return on invested capital, are all best in class for Clicks
— Paul Steegers
William Meyer, owner of Fenestra Asset Management, says that on the fundamentals Clicks and Dis-Chem are pretty similar and both are growing between 14% and 15% on an annual basis. “Clicks has a slightly higher earnings multiple at 30; Dis-Chem is at 26. Clicks is rated a bit higher but has similar forward-looking growth forecasts and runway.”
Meyer contends that there’s nothing to get excited about on the share graphs. “When you have two companies with earnings multiples at basically double the growth rate, they’re not in bargain territory.”
Others hold a different view. Paul Steegers, senior equity research analyst at Nedbank, says Clicks and Dis-Chem are both growth stories. But he argues Clicks has had a better balance sheet, higher returns, better cash generation and more consistent delivery against expectations. “We think a premium valuation to Dis-Chem is still warranted, because we think Clicks has some of the strongest structural growth opportunities in the South African retail sector.”
These structural opportunities, which Dis-Chem also has, are based on fairly low corporate pharmacy retail penetration in South Africa. Clicks and Dis-Chem each has a market share of about 26%. This means there is still about 40% in the hands of independent pharmacists, even though the sector has been consolidating for more than two decades.
That period has seen population growth and the commensurate rise in per capita spend on health and beauty from low levels.
Clicks has more than 900 stores, and Steegers believes that the group could reach its medium-term target of 1,200.
“The metrics … the operating margins, the cash generation, the return on invested capital, are all best in class for Clicks — not just in the context of South African retail but also against global emerging-market peers. The company deserves a premium.”
Steegers has a better earnings growth outlook for Dis-Chem. He points out that it has had faster space growth than Clicks since it listed in 2015.
He adds that Dis-Chem is focusing on controlling costs and improving efficiencies, giving it more potential margin upside, and higher growth opportunities, with more possible store rollouts than Clicks. “The problem with Dis-Chem is execution risk. So far it has not really proved that it can open those stores as aggressively as it has highlighted. It seems to be taking slightly longer than expected.”
Dis-Chem has an aggressive rollout plan for new stores over the next few years but Clicks is seen as having better potential for growth and overall revenue. “The like-for-like revenue growth of Dis-Chem has been below that of Clicks for the past nine years.”
Steegers forecasts improved sales densities for both Clicks and Dis-Chem over the next three years but sees faster improvement at Dis-Chem.
Clicks is looking to roll out another 10 UniHealth pharmacy stores (formerly M-Kem). They will be smaller than traditional Clicks stores, have longer opening hours and offer additional services, such as diabetes and travel clinics. These could add an additional R100m to revenue, according to management.
The group is also testing the primary care drug therapy pharmacy model, which allows pharmacists with additional training to prescribe up to schedule 3 and 4 drugs without the patient having to see a doctor.
Clicks has consistently delivered 10%-15% headline earnings growth. “We see scope for further share price outperformance on a 12-month view,” says a note by Steegers last month.
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