Company overview - Australian Pharmaceutical Industries Limited is a pharmaceutical distributor, and health and beauty retailer. The Company operates through two segments: Australia, which is engaged in the distribution of pharmaceutical, medical, health, beauty and lifestyle products to pharmacies, the purchase and sale of various health, beauty and lifestyle products within the retail industry, and the provision of retail services to pharmacies, and New Zealand, which manufactures and owns rights of pharmaceutical medicines and consumer toiletries. Its services include wholesale product delivery, retail services, marketing programs and business advisory services. Its brands include Priceline & Priceline Pharmacy, which is a health, beauty and wellbeing retailer; Soul Pattinson Chemist, which is a pharmacy brand; Pharmacist Advice, which offers professional service and advice; Club Premium, which is a club for independent pharmacies, and Pharmacy Best Buys, which offers a catalog program.
 

API Details

Moderate performance despite sluggish retail conditions: During H1FY17, Australian Pharmaceutical Industries Limited (API) reported 15% yoy growth in NPAT at $29.1m for the six months to 28 February 2017. Reported NPAT was 27.2% up on the pcp, which included a $2.4m loss on the sale of API’s shareholding in CH2 in the previous year. The company has increased NPAT and returns to shareholders through organic growth in Priceline Pharmacy network, despite the sluggish retail conditions in 2017, while generating cash and sustainable returns through its pharmacy distribution business.  Return on equity had a compound annual growth rate of 19.1% since 1H15 and return on capital employed had a 13.0% increase in the same period. Further, working capital improved on all key metrics on the pcp and inventory returned to normal levels for the seasonal trading period. Reported net debt decreased $84.4m from the same time last year and is expected to decrease for the full year.


H1FY17 Financial overview; (Source: Company reports)
 
Healthy pipeline of potential partners: The Priceline Pharmacy network expanded by 25 stores to 450 stores, during the last twelve months. Total retail network register sales were up by 7.2% which included robust growth in dispensary, while comparable store sales were up 0.4%. The brand also increased its market share in the total health and beauty sector, while gaining market share predominantly in dispensary, skincare, OTC health and color cosmetic segments. Moreover, the strength of the Priceline Pharmacy brand continues to attract independent pharmacists to its network and the pipeline of potential partners remains robust. Despite consumer sentiment being challenging for the foreseeable future and competition increasing, the strength of its combined marketing assets, particularly Sister Club loyalty program which now has 6.7 million members, and unrivalled health and beauty range should enable the company to maintain and grow its market share. The company continues to lead the sector in bringing a unique, new and exclusive product offering to market across categories.


Priceline pharmacy category MAT growth; (Source: Company reports)
 
Pharmacy distribution performance remains strong: API’s pharmacy distribution revenues grew by 18.0% yoy, led by the new high-value hepatitis C medicines, and the normalized revenue (after removing the effect of the introduction of the hepatitis C medicines and PBS reform), underlying growth stood at 5.9%. The pharmacy distribution business performed well in remain testing conditions. Ongoing growth in accounts in Western Australia is behind a new distribution center in Perth that will incur a capex cost of $5 million, and it will result in more timely and efficient stock management for both independent pharmacy customers and Priceline Pharmacy franchise partners. API remains active in the Review of Pharmacy Remuneration and Regulation through its membership of the National Pharmaceutical Services Association and is confident of a collaborative outcome that is sustainable for the industry. API’s New Zealand business has experienced a short-term decline in earnings due to the reduced demand in contract manufacturing for Australian businesses from the changes in scheduling and PBS listing of key products. However, the demand is expected to return during the second half with new contracts secured in the 2017 calendar year.


Pharmacy distribution results; (Source: Company reports)

Continue to capture the market share in key categories: During FY16, the company reported 11.1% yoy growth in total revenue at $3.8 billion, and 20.3% yoy growth in reported EBITDA to $113.6m. Underlying NPAT was up 18.0% to $51.4m on the prior corresponding period. Reported NPAT stood at $51.7m, which includes the previously announced $2.4m loss on the sale of API’s shareholding in associate CH2 and a $2.7m net after tax benefit relating to prior year write down.  Reported net debt dropped by $44.9m from $70.8m at the end of FY15 to $25.9m as working capital returned to normal levels.  During the year underlying return on capital employed has increased 204 basis points to 15.49%, while the underlying return on equity has also grown to 9.58%, up 96 basis points from FY15. In returning working capital to normal levels the cash conversion cycle has also improved to 23.9 days, compared to 26.1 days in FY15.


FY16 Income statement; (Source: Company reports)

Expanding the network through franchise partners: The Priceline Pharmacy network has reached a record 442 stores, up from 420 at the end of the FY15. Overall retail sales for the period were up 7.6% to $1.15 billion and comparable store sales growth was 2.8%. Including dispensary sales, overall retail sales were circa $2 billion, 11.7% up on the prior year. The sales growth has been consistently driven by two factors; by attracting new franchise partners to the brand to expand the network and by increasing comparable store sales. Further, the company is continuing to take market share in the key categories of colour cosmetics, skincare, over-the-counter health and prescriptions which together are the heartland for its business. Pharmacy Distribution revenues grew by 11.2% primarily from the effect of the new high value Hepatitis C treatments. Normalized for the effect of PBS Reforms and Hepatitis C medicines underlying growth stood at 4.8% yoy. During the year, Club Premium maintained as one of the most popular independent offerings in the market with more than 770 customers, while supporting broadening of service-based community pharmacy model through active development of Soul Pattinson and Pharmacist Advice models.


Retail growth profile; (Source: Company reports)

Outlook & Recommendation: API expects its Priceline Pharmacy network to expand by at least 20 stores during the current financial year end to 462. API also expects to generate further operational improvements due to major capital investments made in recent years. The company expects that consumer sentiment is likely to remain more challenging than in previous years, however remain confident in its retail store pipeline and in reducing operational costs as a consequence of prior capital investments. API expects another year of record full year net profit after tax, a minimum 10% up on FY16. The stock has declined over 15% in the last three months, while it is down 4.4% in the past one year, and trading close to it 52-week low levels. Given the long term strategic initiatives to increase the market share, while improving the operating margins, we give a “Buy” recommendation at the current price of $1.727


API Daily chart; (Source: Company reports)
 

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