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Andrew Allentuck

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All lipstick, no pig

Andrew Allentuck


WINNIPEG (GlobeinvestorGOLD) — Shoppers Drug Mart Corp. isn't your granddad's pharmacy. A retail colossus that operates out of 978 locations across Canada, it generated sales of $4.7-billion for the year ended Jan. 1, 2005. In the three calendar years that have passed since the company went public in November, 2001, it generated earnings-per-share growth at a compound rate of 15 per cent per year. That's not bad for a business that is about filling patients' prescriptions at the back of the store and selling shampoo up front.

The profits keep rolling in. On July 19, Shoppers said that net earnings for the quarter ended June 18, 2005 were $80-million or 37 cents per share compared with 32 cents per share in the same period a year earlier. Driving those earnings were prescription sales, up 9 per cent, and front store merchandise sales that produced 8.4-per-cent growth in the latest quarter.

Boosting sales in the highly competitive drugstore sector is no mean achievement. Retailers such as Wal-Mart Stores Inc. and grocers like Loblaw Cos. are trying to work the synergies that come from getting shoppers to get their prescriptions filled where they shop for food and general merchandise. Adding to competition is the increasing use of generic drugs that tend to be priced below brand name drugs. That trend reduces drug sales measured in dollars, but in the curious world of drugstore economics, it actually can raise profit as a percentage of sales. That result is due to the pharmacy's main source of profit — the dispensing fee that is often a constant regardless of the cost of the drugs involved.

What makes Shoppers distinctive as a combo pill-and-merchandise vendor is the way it has put together pharmacy — which is due to thrive as the population of Canada ages and increases its use of medicines for chronic conditions — and personal care products, especially cosmetics, which generate large margins. Grocery margins and discounters' margins pale in comparison.

Shoppers is taking steps to ensure its growth continues. The drugstore business flourishes with rising scale of operations. To boost its scale, Shoppers adds stores at an aggressive rate. In the second quarter, the company announced that it added 18 stores. In a recent report, CIBC World Markets figured that the company can enhance sales by expanding stores, remodeling existing ones and in some cases moving to better locations. By the end of 2005, CIBC expects the company to have 270 stores, about 28 per cent of its total store count, refurbished to its new standards. That leaves several hundred more stores to be remodeled, a roster than could take eight to 10 years to complete. If the company adds 250 to 300 new locations, then there could be as many as 1,300 stores under the Shoppers banner by the end of 2013, CIBC said.

Shoppers' is not a cheap stock. It trades at 24 times estimated 2005 earnings, compared to 18 for Loblaw and 19 for Jean Coutu Group Inc. In comparison, such U.S. drug chains as Walgreen Co. trade at 30 times expected earnings.

Can Shoppers maintain its profit growth and ascendant stock price?

"It has been a good growth stock for us," said Sal Pellettieri, a quantitiative analyst with IG Investment Management Ltd. in Toronto. But there are some signs that the stock is expensive, he noted. "The stock is priced at 4.2 times book value, which is high compared to other consumer staples stocks."

In spite of the high valuation the market has accorded it, Shoppers continues to attract institutional investors.

"I like the company," said Jackee Pratt, vice president of Mavrix Fund Management Inc. in Toronto and portfolio manager of the Mavrix Diversified Fund and the Mavrix Canada Fund. "The company has a good record of earnings growth, and while the company does trade at a premium to other consumer staples companies like Loblaws, Shoppers can sustain its growth." Ms. Pratt noted that Shoppers boosts sales and generates repeat traffic through the use of its Optimum brand loyalty card. As well, Shoppers has choice high volume locations and 24/7 store hours in some locations, she explained.

"What Shoppers offers the investor is consistency of earnings rather than raw growth," Ms. Pratt said. "There are risks that it may not be able to maintain margins. But the company is well managed and the record of earnings shows the company is doing things right."

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

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