Sugi Holdings Co., Ltd. (SUGI) engages in the retail of pharmaceutical products and healthcare-related services in Japan. Via its subsidiaries, it operates in two (2) key segments, namely (i) Pharmacy and (ii) Drug. The Pharmacy segment sells pharmaceutical products, health foods, cosmetics, and miscellaneous goods. Meanwhile, its Drug segment deals with the operation of drugstores.

Sustainable earnings. Being one of the leading pharmaceutical retailer and drugstore operators in Japan, SUGI managed to record sustainable profitability with a 5-year CAGR revenue and net profit growth of 6.4%/10.2% respectively. For the past 5 years, the company has consistently been recording an average EBITDA and net profit margins of 6.2% and 3.4%, respectively, underpinned by its vast effort on expanding its number of retail stores in Japan. It grew from 774 stores in 2010 to 1,011 stores as of June-2016.

Catalysts. According to the company’s Investor Relations webpage (www.drug-sugi.co.jp/hd/ir/ir_english/), SUGI is looking to provide more products and services in tandem with the growing healthcare demand in Japan. The initiative is taken in view of the greying population in Japan, whereby approximately 40% of Japanese population will be over the age of 65 years by the year 2030, according to IMF. This trend could lead to a huge increase in number of patients receiving care at home or nursing homes. Hence, SUGI looks to include dispatching stores’ pharmacists to patients’ home and nursing homes services, and collaborating with medical providers to deliver medicines, other health care goods and home nursing care services.

Furthermore, the Japanese government is looking to increase the use of generic drugs to make up c.80% of prescriptions in Japan from c.50% currently in the next few years, drugstores and pharmacy operators such as SUGI is expected to be a huge beneficiary. Taking the above into consideration, SUGI’s rapid expansion plans of its own retail outlets will bode well for SUGI, where it could also boost its market share to improve its revenue growth and to provide a sustainable profit margin in the long-run.

Consensus positive on SUGI’s outlook. Looking ahead, Bloomberg consensus is expecting SUGI to record a revenue and net profit growth of 6.5%/8.9% to JPY442.0b/JPY15.9b respectively in FY17E. The aforesaid consensus numbers are very much in line with the SUGI’s internal revenue and net profit forecast of JPY445.0b/JPY15.7b respectively, which was gathered from the latest set of 1Q17 results note. The healthy growth is fuelled by the group’s plan and vision to increase its number of stores nationwide while shifting from “typical drugstores handling OTC and prescription drugs” to its new business model of “drug stores collaboration with community medical providers” that serves not only visitors to its stores but also in-home patients.

An undervalued healthcare gem? Despite having a more conservative earnings growth of 13.6%/9.4% for FY16E/FY17E compared to its peers (as shown in peer table on the back of this report), SUGI is currently trading at FY17E fwd PER of 20.4x, which is undemanding as compared to similarsized peers such as Welcia Holdings Co Ltd (22.0x) and Cosmos Pharmaceutical Co Ltd (26.2x). Besides, the group is currently trading at a 10.5% discount to MSCI Japan Health Care Index FY17E fwd PER of 22.8x. The group’s valuation is also undemanding as they are trading at an enormous discount of c.42% compared to our domestic listed pharmacy chain operator, Caring Pharmacy Group Bhd, whom is trading at FY17E fwd PER of 34.0x. Considering its sizeable market share, consistent track record and healthy balance sheet with a net cash position of c.JPY80.3b, SUGI would be a great proxy for investors who look to leverage one of Japan’s major sociological concerns – the rapid aging population.

Source: Kenanga Research - 2 Sep 2016