Prior to October 2008, Shoppers’ traded at an expensive 20 times earnings. The market awarded it a premium valuation based on its competitive strength, reliable earnings and its leverage to Canada’s aging population. Then in October 2008, Shoppers’ stock fell 25% with the rest of the market, even though its business is recession-resistant. We started buying the stock after the drop at $42. We were excited to get a premium investment for a discount price. Shoppers even thrived in the recession and its earnings grew 4% in 2009 and the company raised its dividend 5%.
What about the Drug Rebate Program? Didn’t you know the risks?
In the summer of 2009, Shoppers as well as all other Ontario pharmacies began negotiating with the Ontario government for fair changes to the plan. Most analysts believed that the only change to the current plan would be for pharmacies to rebate some of the allowances received for selling generic drugs to seniors and low income families. While this would have affected Shoppers’ earnings modestly, we believed that this outcome was already priced in to Shoppers’ stock. Shoppers stock performed poorly in 2009 relative to the market.
What do we do now?
Shoppers’ stock is now down $6 for the month of April on what we believe is a 50 cent per share impact on future earnings going forward. Shoppers will earn close to $3 per share in 2010 and when the new changes to the Drug Rebate plan take place later this year, earnings could fall to $2.90 in 2011. For momentum based investors, there is no point in holding on to Shoppers’ stock. Earnings will be flat for the next two years. For value investors, this is a great time to buy the stock. The earnings multiple is cheap and Shoppers will still benefit from our aging population’s need for more health care. Shoppers may even benefit in the long run, as over 50% of its sales are from non-prescription products. An independent pharmacy generates over 80% of its revenue from prescriptions. Many will close over the next two years, leaving Shoppers to pick up a lot more customers. In the meantime, Shoppers will probably slow down its new store openings which will mean higher free cash flow and higher dividends for shareholders.
We intend to continue to hold the stock and buy more for new clients. Long term patient investors will be well rewarded.