CARING’s  management  disclosed  at  our  corporate  luncheon  that  it plans to open  12-15 new pharmacies annually. It also hinted  that it will pay  dividends  above  the  30% minimum stipulated during its IPO. This upbeat  tone  prompts  us  to  upgrade  our  earnings  forecast  and  FV  to MYR2.38  (from  MYR2.28).  Our  target  P/E  remains  at  18x  CY14  EPS, which is at a discount to larger-cap healthcare stocks.

• Highlights  from  RHB’s  13  Jan  corporate  luncheon  talk.  CARING’s management  was  represented  by  its  MD  and  executive  director,  Mr Chong Yeow Siang.  The event was attended by 14 fund managers.  The company,  which is  confident  on  its  store  expansion  plans and  industry outlook,  provided insights on its  competitive strategy, staff  attraction  and retention plans, cost structure, and other main concerns.
• The  tasty  bits.  The  notable  takeaways  from  the  event  are  CARING’s targets to: i) be a serious player in  the  retail healthcare segment  rather than moving  into consumer  lifestyle  products, ii)  open 12-15 outlets per year  –  higher  than  our  initial  assumption  of  11  annually,  iii)  focus  on Klang Valley suburbs  to  cement  its already  dominant  market share,  iv) contemplate  undertaking  M&As  to  accelerate  growth,  and  v)  also consider a higher dividend payout than what was set earlier.
• Upgrade  FV  to  MYR2.38  (from  MYR2.28).  Following  the  insights gleaned from the luncheon, we  raise our FY14/15/16 net profit forecasts by  3.0/4.4/5.5%  respectively.  This  accordingly  lifts  our  FV  to  MYR2.38 (from  MYR2.28),  based  on  an  unchanged  18x  CY2014F  P/E.  This represents  a  discount  to  the  larger  cap  healthcare  stocks,  and  is comparable  to  the  mid-cap  consumer  plays.  We  now  expect  a  40% dividend  payout  ratio  instead  of  30%,  which  will  equate  to  decent  2.0-2.4% net yields for FY14F-15F.
• Further  upside  seen.  We  like  CARING’s  defensive  earnings  with dividends  to  boot,  its  hands-on  management  as  well  as  market leadership.  We think the company  still has the ability to surprise on the upside  with a better store mix, margins improvement and cost efficiency. Its  valuations  are  justified  by:  i)  the  scarcity  of  pure  pharmacy  plays locally  and  regionally,  ii)  its  resilient  store  sales,  iii)  stable  ROEs  of  c. 24%, and iv) a strong 3-year earnings CAGR of 20.3%. Maintain BUY.

The Luncheon Treats
Strong expansion plans  to  cement market leadership.  CARING  aims to open 12-15 stores annually, having  already  opened 10 new outlets  YTD. These new outlets boost its  chain to  a total  90 pharmacies,  hot on the heels of  Cosway  and  Guardian,and almost 1.5x the size of Watson’s.

In the coming months,  CARING  will ramp up expansion in Greater Klang Valley  and potentially  target  the  suburban  areas  too.  Based  on  its  management’s  cost-benefit analysis,  suburban stores tend to generate lower topline sales but profitability is  not compromised as these  outlets incur  far lower rental  costs. Currently,  the group  is the dominant pharmacy chain in the Klang Valley, with 72 outlets under its stable. Among its upcoming outlets are two pharmacies to be located in KLIA2.

Industry dynamics  give  room for M&As.  We agree with  management’s view that the  fragmented  state  of  Malaysia’s  pharmacy  industry  provides  opportunities  for M&As,  which  could  lead  to  accelerating  earnings.  While  there  were  605  corporate bodies  registered  with  the  Malaysian  Pharmacy  Board  as  at  end-2012,  we  only identified eight operators with more than 20 outl ets each. Of this, only the  top  four operate more than 30  pharmacies, namely:  i)  Guardian  –  102, ii)  Cosway  –  100, iii) CARING – 90, and iv) Watson’s – 62.

Maintaining  focus  on  healthcare.  CARING  sees  itself  as  a  healthcare-focused retail player and does not intend to deviate into consumer goods like its competitors have. This is clearly seen from the fact that 100% of its outlets are pharmacies, while both  Guardian  and  Watson’s  outlets  are  mainly  personal  care  stores,  with pharmacies  making  up  only  24.3%  and  21.2%  of  their  total  stores  respectively. Cosway’s  outlets  are  predominantly  pharmacies  (73.0%),  although  the  company  is generally still a multi-level marketing operation.

Healthcare  focus  proves  rewarding.  We  see  tangible  benefits  from  CARING’s decision to focus on healthcare.  Based on the  group’s  past four financial years,  its GPM and revenue growth compare favourably against Watson’s, a unit of Hong Kong conglomerate Hutchinson Whampoa (13 HK, NR) that owns 293 stores in Malaysia – out  of  which  only  62  are  pharmacies.  We  think  that  CARING  commands  superior margins  due to  its product mix,  as  it focuses  on higher-margin health supplements and drugs.

Compared  to  Health  Lane  Family  Pharmacy  SB  (Health  Lane),  the  next  largest locally-owned pharmacy chain with 25 stores  under its stable, we find that  CARING still registers better overall performance, although the former’s margins have crept up over  the years along with sales.  We think that  Health Lane’s improvement  is due to economies of scale from  its increasing outlet count.  This trend  seems to show that pharmacy-focused chains  enjoy  margins that  are superior to those from  other retail plays and further reinforces our positive view of CARING.

“CARING” for the next generation of pharmacists.  Some of the  questions  raised during the luncheon  related to  management’s main concerns and its staff attraction and  retention  strategies.  CARING  is  mainly  concerned  with  finding  and  training competent new pharmacists to expand its network.

Joint  venture  (JV)  business  model  attracts  talent  and  promotes  succession planning.  The  CARING  JV  scheme  launched  in  2000  offers  entrepreneur-minded pharmacists cum branch managers the  chance to become  JV  partners in operating community pharmacies under the CARING brand.

We  feel  that  this  gives  rise  to  a  symbiotic  relationship  that  is  highly  conducive  for growth.  In its  management’s view,  out-of-state  pharmacists  who have  been  working in  the  Klang  Valley  will  eventually  return  and  expand  the  CARING  brand  in  their home  states  via  the  JV  scheme.  We  also  understand  that  many  CARING pharmacists  plan  to  participate  in  this  scheme.  Currently,  three  out  of  eight  of  the company’s senior management  are former JV partners  that  were promoted  to  their current roles in recognition of their talent.

Healthy  staff  retention.  Since  its  inception  in  2000,  we  understand  that  only  one partner has left the scheme to focus on family matters. The turnover among new staff that  have  been  employed  for  less  than  two  years  –  at  5-10%  per  annum  –  is manageable.

Salient aspects of the JV 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
iii)  Returns  are  shared  and  paid  as  dividends  based  on  the  respective shareholding proportions

Benefits of being a CARING JV partner: 
i)  Entitlement to staff benefits,  eg monthly salary, annual leave etc, giving the partners greater security vs striking out on their own
ii)  Ability  to source  for  other salaried pharmacists from the group to  man their outlets, allowing  partners to go on leave,  eg maternity, holidays, leave taken due to illnesses - without affecting operations
iii)  Access  to  economies  of  scale  in  advertising,  marketing,  purchasing, training and supply chain management

Benefits of having JV partners for CARING: 
i)  Ability to retain qualified and skilled in-store pharmacists
ii)  Ability to expand outlets at a faster pace, allowing it to quickly build up a stronger brand and market presence
iii)  Ability to  maintain  full  control of  CARING’s  brand and  operations of  its outlets

Raising  forecasts  for  pharmacy  outlets  and  earnings.  Coming  away  from CARING’s  briefing  over  lunch,  we  raise  our  FY14/15/16  net  profit  forecast  by 3.0/4.4/5.5% on incorporating the opening of six new street-based outlets per annum vs  our  original  estimate  of  three  outlets.  Our  assumption  is  based  on  the  fact  that CARING will be focusing on suburban locations. All other forecasts are unchanged. Accordingly,  our  FV  is  upgraded  to  MYR2.38,  at  an  unchanged  18x  CY2014  P/E, which  is  at  a  discount  to  larger-cap  healthcare  stocks  but  comparable  to  mid-cap consumer plays. We now expect a 40% dividend payout  ratio  instead of 30%,  which is equivalent to decent 2.0-2.4% yields for FY14-15.

Source: RHB