Highlights/ Comment

From our recent company visit, we came away feeling neutral with negative bias on near-term prospects of the company. We opine that there might be some downside risks on its store expansion plan and profit margin.

Our concern arises due to the disappointing FY05/14 results which, from our understanding, was caused by:

1. Overaggressive outlet expansion. In order to stay on track to achieve its target of 120 outlets by 2016, Caring expanded into competitors’ territories which has taken a toll on sales.
2. Aggressive pricing to attract market share. Expansion into competitive area has forced Caring to undertake aggressive marketing strategies which resulted in a squeeze in margins. Discount vouchers were distributed at the vicinity of new outlets to attract traffic flow. Also, Caring attempted to compete on pricing by offering promotions on their pharmaceutical products.
3.  Longer-than-expected gestation period. Some new outlets have taken longer to breakeven compared to the historical gestation period of 18 months.

Notwithstanding the slight negative bias in its short-term business outlook, we are maintaining hold call on Caring given that:

1.  Management is now aware of the areas overlooked, and has exercised more careful discretion in the location of outlet in future.
2.  Caring will be targeting less saturated area, such as Malacca, Penang and Ipoh, instead of the crowded and competitive Klang valley area.
3. The benefit of the newly installed ERP system is yet to yield positive results in keeping track of the real-time outlet financials & inventory.

Risks

• Overaggressive expansion has resulted in margin compression which may continue to drag earnings growth.
• Keen competition from other pharmacy chains such as Guardian and Watsons.
• Slowdown in consumer discretionary spending.

Forecasts

Updated model with a tweak in margins based on reasons mentioned above. As a result, FY15, FY16 and FY17 EPS were trimmed by 4.0%, 5.7% and 6.7% respectively.

Rating

HOLD, TP: RM1.94

Positives – Established and trusted pharmacy chain with reliable service and competitive product pricing; full-time registered pharmacists available throughout retail operating hours; benefits from economies of scale and shared services; the only pure retail pharmacy chain listed locally.

Negatives – Higher working capital and start-up costs for new outlets; overaggressive expansion; shares are tightly held resulting in relatively low trading volumes.

Valuation

Reiterate HOLD with a lower fair value of RM1.94 (-4.9% from RM2.04), reflecting our EPS revision. This is derived based on unchanged 17x CY15 EPS, on par with other domestic market-oriented retail pharmacy chain operators in the region.

Source:Hong Leong Investment Bank Research - 15 Aug 2014