We  initiate  coverage  on  Caring  Pharmacy  (CARiNG)  with  a  BUY  and MYR2.28  FV.  It  offers  investors  a  play  on  the  healthcare  and  retail sectors.  Its earnings are non-cyclical  and  organic growth is strong. We do not rule out M&As in the near future. CARiNG is a growth stock, with an  18.1%  3-year  (FY13-16)  net  profit  CAGR.  Our  FV  is  pegged  to  18x CY14 P/E, which is a discount to mid-cap healthcare and retail plays.

• Malaysia’s third  largest pharmacy chain and still growing.  Built over 19  years  by  dedicated  owner-operators,  CARiNG  is  Malaysia’s  third largest  pharmacy  chain  with  85  outlets,  competing  neck-and-neck  with regional  chains  such  as  Guardian  and  Watsons  locally.  Founded  by seasoned  pharmacists,  CARiNG  renews  its  entrepreneurial  drive  by recruiting  new joint venture  (JV) partners,  thereby  driving  expansion and securing succession.
• “Healthiest” consumer play in town.  With over 50% of sales derived from  health supplements and  personal care products, we see CARiNG benefiting  from  spending  by  increasingly  health-conscious  consumers. As Malaysia’s  second largest pharmacy operator, it  is well positioned to capitalise on the secular  trends of:  i) an aging but affluent population, ii) the  prevalence  of  lifestyle  diseases,  and  iii)  the  resulting  rise  in supplement/multivitamin  consumption.  It  offers  the  defensive  quality  of healthcare companies  while tapping into growing  consumer spending on “non-discretionary” health products.
• Growth stock with 3-year (FY13-FY16) net profit CAGR of 18.1% and growth upside potential. CARiNG targets to open 30-35 new outlets by FY16. We are projecting for 30 new outlets and MYR24.8m/29.8m/33.8m in net profit for FY14/15/16  respectively  under  our base case scenario.As  we  also  do  not  discount  the  possibility  of  the  group  taking  an inorganic  growth  path,  we  think  the  prospects  of  M&As  may  add excitement to the stock.
• We  value  CARiNG  at  18x  CY14  P/E,  comparable  to  its  mid-cap consumer  peers  and  at  a  discount  to  mid-cap  healthcare  and  retail players. Valuations are justified, given: i) the scarcity of pure pharmacy plays  locally  and  regionally,  ii)  resilient  store  sales,  iii)  stable  ROEs  of c.23%, and iv) strong earnings growth of an 18.1% 3-year CAGR.

Background & Management
A company of pharmacists, by pharmacists.  Founded in 1994, Caring Pharmacy Group is an operator of community pharmacies under the  CARiNG brand.  Eight  out of 10 of its senior management are registered pharmacists. Directors and management.  Four out  of six members  of the board of directors  are founders:  i)  Mr  Chong  Yeow  Siang  (managing  director),  ii)  Mr  Soo  Chan  Chiew (director),  iii)  Mr Tan Lean Boon (director) and  iv)  Mr Ang Khoon Lim (director).  The quartet  is  the  driving  force  behind  CARiNG.  To  date,  all  founders  –  each  with  20 years  of  experience  as  pharmacists  -  remain  owners  and  are  actively  involved  in management.  They remain the controlling shareholders (50.4%) via  Motivasi Optima SB.  The other two are  Datin Sunita Mei-Lin Rajakumar (independent non-executive chairman) and Tan Sri Haji Mohd Ariffin (independent non-executive director).

To  further  spur  growth,  the  group  harnessed  the  entrepreneurial  drive  of  younger pharmacists  by  establishing  the  “CARiNG  Joint  Venture  Scheme”  in  2000, encouraging eager branch managers to take up to a 50% stake in outlets - essentially making them business owners  who still enjoy CARiNG’s support. Currently, three out of  eight  members  of  its  senior  management  are  former  JV  partners  who  were promoted into the group on recognition of their talent.

19  years,  85  branches,  154  pharmacists.  From  its  original  pioneer  branch  in Taman  Muda  Cheras  in  1994,  CARiNG  is  now  Malaysia’s  third  largest  pharmacy chain  in terms of outlets,  with 85  pharmacies  (at prospectus date),  competing withregional  chains  like  Guardian  (102  outlets)  and  Watsons  (61).  Within  the  Klang Valley, Johor, Malacca, Perak and Penang, it  now enjoys an estimated  3.9% market share of pharmacies in Malaysia, while employing 1.4% of registered pharmacists. Of the 85 outlets, 26 are wholly owned and 59 partially owned.

Sales And Profit Drivers 
Branch presence.  The  85 outlets  comprise  43 street outlets  (SBOs),  35 shopping complex-based  outlets  (SCOs)  and  six  specialised  retail  centres  which  contributed 49.2%,  45.9%  and  4.4%  to  FY13  sales.  A  small  percentage  (0.5%)  of  sales  are generated  by  the  CARiNG  eStore  as  well  as  warehouse  and  roadshow  sales.  In terms  of  average  store  sales,  SCOs  rank  the  highest,  steadily  generating  sales  of MYR4.3m-4.6m per annum  each  in  FY10-13.  SBOs recorded  revenue of  MYR3.0m-3.8m per annum each and retail centres average MYR2.3m for the period.

A  “health-conscious  consumer  staple”  focus.  Pharmaceutical  products (comprising scheduled  and  over-the-counter (OTC)  drugs, health supplements)  have historically  been  CARiNG’s  largest  contributor,  accounting  for  62.2-66.5%  of  sales and 65.1-68.7% of gross profit  (GP)  in  FY10-13. GP  margins  were  steady at 27.0-28.1%  over  the  period.  The  second  largest  product  segment  is  personal  care products (20.9-23.8% of sales and 20.9-23.8% of gross profit). GP margins, too, were stable at 23.8-24.5% in FY10-13.

Focusing  on  “consumption-driven”  health  supplements  and  personal  care  products (HSPC), we notice a stable rise in combined GP margins (from 24.6% to 25.9%) and percentage contribution (47.0%  to 52.1%)  to GP  over the four  years,  equating to a 23.6% GP CAGR, underscoring CARiNG’s consumer staple-driven aspect.

Business Structure And IPO 
The  “CARiNG  Joint  Venture”  business  model  explained.  The  CARiNG  Joint Venture Scheme was launched in 2000, offering  pharmacists cum  branch managers eager  to  own  their  businesses  the  chance  to  be  joint  venture  (JV)  partners  in operating community pharmacies under the  CARiNG  brand. We feel this creates a symbiotic scenario highly conducive for growth. Salient aspects of the scheme:

Overall structure: 
i)  CARiNG  will  hold  50.0%  or  more  of  the  JV  and  retain  management control over operations;
ii)  CARiNG  provides  support  services  such  as  assistance  in  planning, management, marketing and training of staff; and
iii)  Returns  are  then  shared  and  paid  as  dividends,  based  on  the respective shareholding proportions.

Benefits of being a CARiNG JV partner: 
i)  JV partners are still  entitled to staff benefits, eg  monthly salary, annual leave etc, giving them great security vs striking out on their own;
ii)  Able to source other salaried pharmacists  from the group  to man their outlets,  allowing the partners to take leave without affecting operations; and
iii)  Economies of scale for advertising, marketing purchasing, training and supply chain management.

Benefits of having JV partners for CARiNG: 
i)  Able to retain qualified and skilled in-store pharmacists;
ii)  CARiNG is able to expand outlets at a faster pace,  allowing it to quickly build up a stronger brand and market presence; and
iii)  Full control remains with CARiNG.

In 13 years,  the number of partners has grown to 58 via 3 3 companies owning 59 pharmacy outlets. We understand that  throughout the 13 years, only one  JV partner has left the scheme.

Listing for expansion purposes. CARiNG IPO’s raised MYR43.8m via the issuance of 35m new shares.  Of the  IPO  proceeds,  41.1%, or  MYR18.0m  will be used for:  i) capex (MYR6.0m)  and working capital  (MYR12.0m)  to fund its plan to expand by 30-35  outlets  over  the  next  30  months.  CARiNG  in  2011  purchased  a  33,778  sq  ft factory lot in Petaling Jaya’s  Old Town  area  to house its new central warehouse and head office. MYR4.0m will be used to partially fund this project,  of which  completion is expected by 2014.

Industry Outlook & Opportunities 
Currently  Klang  Valley-centric.  CARiNG  currently  enjoys  an  estimated  3.9% market share of total pharmacies in Malaysia. Its market presence is  the  strongest in Kuala Lumpur  with an 11.1% market share,  and 7.3% in  Selangor. Sales per store averaged MYR4.3m and MYR3.7m in the two states respectively for FY13. In the newer markets of Johor, Penang, Perak and Malacca, its  market share stands at 4.6%, 0.8%, 1.2% and 2.8% respectively. As expected with newer stores, average sales, too, is lower in these states, at MYR1.2m-2.9m in FY13.

Our  present  lifestyle  needs  more  “CARiNG”.  According  to  a  Social  Security Organisation  (SOCSO)  survey  presentation  by  the  University  of  Malaya  on  Sept 2013,  many  Malaysians suffer from  a wide range of lifestyle diseases,  underscoring demand  for  both  prescription  medication  and  health  supplements.  Among  the  key points of the findings:  i) 15.0% of Malaysians above 18 are found to be diabetic and this  number rises to 17.6% for those above 40 years old, ii) hypertension,  too,  was prevalent,  afflicting  35.8%  of  those  in  the  same  age  group,  iii)  among  the  working population,  20.0%  are  estimated  to  be  smokers,  and  iv)  58.0%  of  those  surveyed suffer from hypercholesterolemia.

Placing  healthier  lifestyles  within  easy  reach.  CARiNG  distinguishes  itself  from most  of  the  competition  by  ensuring  the  presence  of  pharmacists  throughout  its outlets’  operating  hours,  eg  CARiNG  Avenue  K  has  a  pharmacist  stationed  from 10am to 10pm, while  other operators might only offer a pharmacist’s services during normal office working hours, ie 9am to 7pm. This gives CARiNG an edge as: i) working customers are able to fill prescriptions well after  office  hours,  ii)  this  drives  more  foot  traffic  to  its  pharmacies,  and  iii)  boosts brand  loyalty  as  the  outlet’s  pharmacist(s)  builds  trust  and  strengthens  his/her relationship with customers.

Room for expansion.  According to World Health Organisation (WHO)  guidelines,  a 1:2,000  pharmacist-to-population  ratio  is  required  to  achieve  the  optimum  level  of healthcare  for  a developed nation. Based on Malaysia’s population of 29.3m  at end-2012,  the  recommended  number  of  pharmacists  equalled  14,650.  However,  there were  only  9,886  fully-registered  pharmacists  and  1,208  provisional  registered pharmacists in Malaysia, which pointed to a shortfall of 3,556.

30-35  new  outlets  by  FY16.  We  believe  CARiNG  will  over  the  next  30  months concentrate its efforts on opening  shopping complex-based outlets  in Selangor and Kuala Lumpur. At prospectus date, 17 locations had been iden tified for new outlets  -in Selangor (12), KL (3) and one each in Johor and Malacca.  Of  the 17, 14 are  to be based in shopping malls (SCOs), where average store sales  have historically been highest. Two outlets will be located in  KLIA2, and  there will be only  one street-based outlet (SBO) which will be located in the Jonker Walk tourist centre of Malacca. As of November,  two  of  the  17  outlets  have  opened  and  the  third  is  set  to  open  in  Dec

“Pan Malaysian” ambitions. CARiNG has shown its appetite for inorganic growth in the past. To boost its Johor presence, in 2011 the group  acquired Medi-home  SB,which  owned  four  outlets  at  the  time.  It  is  now  a  51%-owned  JV  named  CARiNG (IDR) SB, operating five outlets in Johor. Operations of CARiNG (IDR) SB broke even in  the  second  year  after  acquisition,  in  FY13.  Thus,  we  think  that,  as  15  of  its  17 identified new outlets are in the Klang Valley, CARiNG  will  seek to  capitalise  on its better brand recognition and financial profile post listing to  expand into other regions, eg east coast states, Sabah and Sarawak, either organically or via M&As.

Inorganic  growth  the  route  to  grow?  We  do  see  opportunities  for  M&As  in  the fragmented  pharmacy  industry.  While  as  at  end-2012  there  were  605  corporate bodies registered with the Malaysian Pharmacy Board, we have only identified  eight operators  with  more  than  20  outlets  each.  Of  that,  only  the  top  four  operate  more than 30 pharmacies, namely;  i)  Cosway  –  136, ii)  Guardian  –  102, iii)  CARiNG  –  85, and iv) Watsons – 61.

Smaller operators might be drawn to join CARiNG as; 
i)  Profitability  would  be  immediately  boosted  by  economies  of  scale  in procurement, advertising and promotions, distribution, etc;
ii)  Ability  to  tap  into  CARiNG’s  large  pool  of  pharmacists  to  increase operating hours; and
iii)  Under  its  JV  scheme,  existing  owners  would  still  be  able  to  keep  a stake in their businesses

Source: RHB