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

Despite encountering challenges in retail pharmacy conditions, Australian Pharmaceutical Industries Ltd (ASX: API) is seen to witness improvement in its financial metrics (ROCE, cash conversion cycle, etc.) in FY17 and this offsets the pharmacy trading conditions to a material extent. The group is putting efforts to sustain profitable growth going forward and expects a continued conversion of banners/independent pharmacies to the Priceline model while benefiting from operating leverage on franchise service fees and improving distribution volumes. 

Improving ROCE: Australian Pharmaceutical Industries enhanced their ROCE by 140 basis points to 16.9% while underlying Return on Equity (ROE) improved 20 basis points to 9.8%. Their ROE grew at a CAGR of 14.2% during FY15 to FY17, while ROCE rose at a CAGR of 26.5% in the last three years. The group’s underlying NPAT rose 5.4% yoy to $54.2 million for FY17, better than earlier forecasts. Their revenues rose 5.8% to $4.06 billion while EBITDA rose 3.8% to $117.9 million during the period. Underlying EPS increased 5.7% year on year (yoy) to 11.1 cents per share. Meanwhile, the group has cut their cost of doing business (as of % of revenue) to 9.4% during FY17 as compared to 9.7% in FY16.
 

Rising NPAT and falling CODB (Source: Company Reports)
 
Expanding Priceline Pharmacy network:Australian Pharmaceutical Industries continued to enhance their Priceline Pharmacy network by 20 stores, which reached 462 stores in FY17 from 442 in the prior corresponding period.  They delivered a retail register sales rise of 2.0% during the period to $1.15 billion.  Overall, retail sales for the network (including dispensary) rose 5% yoy to $2.1 billion during the financial year driven by major health categories especially in dispensary as well as over-the counter medicines both of which enhanced their market share. To offset the tough market conditions, the group launched new products in trending categories, which showed a strong value. The group also undertook unique initiatives in their store services like making Beauty Advisor appointments. The group executed phase one of their Sister Club relaunch to introduce tiering in 2017 with enhanced benefits for members. They started phase two with an investment that would maximize their ability to offer more immediate, personalized offers to customers. The group is taking such initiatives to retain the members of their Sister Club for high level of relevance to the 7.1 million members’ base which is their core valuable asset. The roll out of the ‘new generation’ store format is picking up while the group is offering dedicated service counters and personal spaces to test and try new products. The group is now maintaining a higher in-stock level across its major lines driven by a new replenishment model while also enhance the stock productivity for franchise partners.
 

Improving retail performance despite tough market conditions (Source: Company Reports)
 
Improving distribution revenue:The group’s Pharmacy Distribution revenues enhanced 7.3% on a yoy basis, on track with their issued guidance. After normalized effect of PBS Reforms and Hepatitis C medicines, the segment’s sales revenue enhanced 7.5% during the year. The group was able to enhance their national market position despite rising competition while continued to manage the effects of PBS Reforms effectively with pharmacists. API opened a new distribution center in Western Australia in 2017 for $5 million, which has complemented their infrastructure investments.
The group is also enhancing their investment in the development of professional services for stores as this area promises pharmacists’ future remuneration potential. The group has been waiting for the outcome of the Government’s review of pharmacy remuneration and regulation, and accordingly is working with the industry’s peak body, the National Pharmaceutical Services Association. The group’s performance of the New Zealand manufacturing business also enhanced during the second half of the year driven by new manufacturing contracts, but the overall sales lost 5.4% while gross profit reached 6.8% against the earlier year. However, the group expects to continue with the better earnings performance experienced during the second half of FY17 through to FY18.
 

Growth of core business (Source: Company Reports)
 
Balance sheet and dividend scenario: The group enhanced the inventory levels for FY17 driven by their efficiency initiatives even though the Hep C volume were low. They also improved the in-stock position by 220 basis points as compared to the last year while their A-lines in-stock also increased 300 basis points. The group’s OneChannel delivery system enhanced in-stock. API enhanced their cash conversion to 1.9 days as compared to the prior corresponding period. The group reported a positive net cash of $7.2 million while their debt metrics continued to improve. The finance costs were slashed by $2.9 million on a year-on-year basis while the group continued to focus on cash management. The group improved their fully franked dividends by 17% yoy to 7 cents per share, as compared to 6 cents in the prior year. The group’s dividends grew at a CAGR of 29.3% during the three years from FY15 to FY17. These dividends represented 65% payout ratio, while the group intends to maintain this going forward. The group spent $26.5 million which includes investing on new stores and refurbishments.
 
Outlook:The group continues to focus on optimal retail offer for their Priceline Pharmacy customers. They intend to continue to generate operational improvements driven by their major capital investments in earlier years. The group intends to strengthen their position via a differentiated offer as a major mass market health and beauty retailer in Australia. Their OTC Health delivered an outstanding growth of 12.1% while color cosmetics rising 7% during the period. On the other side, they are targeting to realize more than 20 new Priceline Pharmacies in the coming year. The group relaunched sister club in 2017 and implemented the phase one initiative. For 2018-19, the group intends to launch Automated eDM capability while improving the flexibility to respond to the market. They also intend to personalize the promotional offers. The group’s OTC focus has seen a spike in manufacturing contracts for major Australian clients in cold & flu and analgesic products and also promising developments in small-scale exports outside Australia. They forecast a better second half as they expect a full value of new contracts to be realized for winter/spring 2018.
 
Stock performance: The shares of API lost over 32.7% in the last six months (as of November 03, 2017) impacted by the weak consumer sentiment and discretionary spending. On the other hand, the group delivered a decent FY17 performance as they retained a strong market position in their core businesses. The group expects an ongoing growth in their Priceline Pharmacy network. They also forecast their Pharmacy Distribution business to be stable. The group has no reported net debt, which is an earlier than expected outcome with support coming in from balance sheet position. Going forward, management intends to maintain their focus on ensuring their customer proposition as well as deliver a profitable growth for their pharmacists and API. They believe that their business strategy would deliver an organic growth while intends to continue to focus on their core assets, especially the product and service offering for their store customers. API stock consolidated in the last four weeks and slightly rose about 0.7% (as of November 03, 2017) and we believe that the stock has room for growth. We give a “Buy” recommendation on the stock at the current price of $1.535

 
API Daily Chart (Source: Thomson Reuters)

Disclaimer

The advice given by Kalkine Pty Ltd and provided on this website is general information only and it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. Kalkine.com.au and associated pages are published by Kalkine Pty Ltd ABN 34 154 808 312 (Australian Financial Services License Number 425376). The information on this website has been prepared from a wide variety of sources, which Kalkine Pty Ltd, to the best of its knowledge and belief, considers accurate. You should make your own enquiries about any investments and we strongly suggest you seek advice before acting upon any recommendation. Kalkine Pty Ltd has made every effort to ensure the reliability of information contained in its newsletters and websites. All information represents our views at the date of publication and may change without notice. To the extent permitted by law, Kalkine Pty Ltd excludes all liability for any loss or damage arising from the use of this website and any information published (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine Pty Ltd hereby limits its liability, to the extent permitted by law to the resupply of services. There may be a product disclosure statement or other offer document for the securities and financial products we write about in Kalkine Reports. You should obtain a copy of the product disclosure statement or offer document before making any decision about whether to acquire the security or product. The link to our Terms & Conditions has been provided please go through them and also have a read of the Financial Services Guide. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine Pty Ltd do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations.