SEM is selling its 75% stake in Caring Pharmacy to BIG Pharmacy Healthcare for of RM637.5m cash. We are positive on the disposal as it is earnings accretive (largely from reduced interest expenses). SEM will be better off redeploying its capital and resources towards growing its convenience store (CVS) business. We raise our FY24F net profit forecast by 11%, lift our TP by 9% to RM2.59 (from RM2.38) and maintain our OUTPERFORM call.

SEM is selling its 75% stake in Caring Pharmacy to BIG Pharmacy Healthcare for RM637.5m cash. At a RM850m valuation in its entirety, the deal values the retail pharmacy chain at 19.6x its historical FY22 PER (when its earnings were supercharged by the pandemic) but 32.7x of our FY24F forecast earnings (which are more normalised post-pandemic). This is at a significant premium to 19x consensus forward PER for the closest comparable issue AHEALTH (Not Rated), which points to a fairly good deal for SEM.

Financial impact. SEM stated that its cost of investment in the stake is RM423.2m. This implies a disposal gain of RM214.3m or RM1.30/share.

In the absence of Caring Pharmacy’s sales, we cut our FY24 top line forecast for SEM by 54%. The impact on EBIT will be lower at only a 5% reduction as Caring Pharmacy’s gross profit margin is lower than SEM’s CVS business, 19% vs. 31%. However, the disposal will be earnings accretive at the net level of 11% on a reduction in interest expenses to the tune of 41%. The disposal proceeds will turn SEM’s net debt and net gearing of RM435.5m and 2.9x as at end-March 2023 to a net cash of RM182.3m.

We are positive on the disposal as we see little synergy between SEM’s CVS operation and retail pharmacy business in the first place, and the non-recurrence of super profits from the retail pharmacy business post pandemic. We believe SEM will be better off redeploying its capital and resources towards growing its CVS business.

On an unchanged FY24F PER of 28x (in line with the industry’s average historical 1-year forward PER), we raise our TP by 9% to RM2.59 (from RM2.38). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

We like SEM for: (i) it being a reopening play (manifested in its weekend traffic having already returned to the pre-pandemic level of about 300 customers/day, and poised for further growth), (ii) its long-term growth potential driven by 7CAFé stores, and (iii) efficiency gains from in sourcing of product distribution (such as chilled products) as well as improved operating leverage of its food processing unit. Maintain OUTPERFORM.

Key risks to our call include: (i) its fresh food and ready-to-eat products failing to gain market traction, (ii) playing field gets more crowded with new entrants or aggressive expansion by existing competitors, and (iii) long-term implication from the generational tobacco ban.

Source: Kenanga Research - 24 Jul 2023