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

Debt free position: Australian Pharmaceutical Industries Ltd (ASX: API) delivered a decent performance for fiscal year of 2017 despite tough market conditions. The group’s underlying NPAT enhanced 5.4% year on year (yoy) to $54.2 million for the twelve months ended 31 August 2017, which is better than their guidance issued in August 2017. Their reported NPAT reached $52.4 million, which included $1.8m in one-off costs related with the offer to acquire Laser Clinics Australia. Overall, revenue for the period rose 5.8% yoy to $4.06 billion while EBITDA improved 3.8% to $117.9 million. Underlying EBITDA rose 6.1% to $120.5 million while the group’s reported EBIT increased 2.5% to $89.3 million against the prior year. API has no net debt as of FY17, which was again achieved ahead of their expectations. Their franchise has been sustainable despite challenges with transactions rising 5.6% while Dispensary volume enhanced by a positive 9.1% for FY17 with Like for like (LFL) at 2.0%. The group also enhanced their working capital with Inventory levels showing improvement as compared to prior corresponding period boosted by their efficiency initiatives. They delivered a net cash positive of $7.2 million while Finance costs decreased $2.9 million year-on-year. The cash conversion improved 1.9 days against prior corresponding period (pcp), at optimal level given seasonal timing. Their CODB (as % of revenue) fell to 9.4% in FY17 from 10.6% in FY15. API delivered a fully franked dividend of 7 cents per share, which is an increase of 17% as compared to 6 cents in the prior year. They would be paying a final dividend of 3.5 cents in December 2017. The dividends for the year represent a 65% payout ratio.
 

FY17 performance highlights (Source: Company reports)
 
Focus on Customer experience: API continues to focus on customer experience via product range, training, services and personalization to remain a preferred choice. They are also addressing the changing customer needs by making rapid decisions. They are simplifying B2B interaction to improve efficiency and time. The group migrated a crucial, billion-dollar online portal to the public cloud. Their Priceline and Soul Pattinson Chemists, run the MyAPI e-commerce portal, wherein pharmacists could order anything from over-the-counter drugs to heavily regulated narcotics. MyAPI has 30,000 products and supplies thousands of pharmacies while comprises 50% of their wholesale orders, worth more than $1.25 billion per year. With MyAPI, the group was able to push customers towards self-service rather than calling or faxing in their orders. Also by migrating their portal to public cloud, the group would be able to control costs by more than 20%.
 
Growing Priceline Pharmacy network: Priceline Pharmacy network has been enhanced by 20 stores to 462 stores as compared to 442 as at the end of last financial year. Retail register sales for the period rose 2.0% to $1.15 billion even though the like for like store sales fell 0.4% against pcp. Overall retail sales for the network rose 5% to $2.1 billion for the financial year. The group’s dispensary and over-the counter medicines enhanced their market share. OTC Health reported a growth of 12.1% while color cosmetics showed a 7% growth. On the other hand, the group’s major beauty categories improved this year driven by their efforts to combat the falling consumer spending. They made new product launches in trending categories, delivering great value and unique in-store services like Beauty Advisor appointments. They also executed phase one of their Sister Club relaunch for better benefits for members. API is currently implementing phase two to maximize their ability to have more immediate, personalized offers for customers. Having 7.1 million members, the group believes that this launch is a much needed one. The roll out of their ‘new generation’ store format is gathering pace which offers dedicated service counters and personal spaces to test and try new products. The group is also maintaining a higher in-stock level across their major lines assisted by a new replenishment model available daily while also improving stock productivity for their franchise partners.
 

Sister Club Relaunch (Source: Company reports)
 
Pharmacy Distribution highlights: Pharmacy Distribution revenues reported a rise of 7.3%; but post the normalized effect of PBS Reforms and Hepatitis C medicines, revenue rose 7.5%. Despite the rising competition with new entrants, the group managed to enhance their national market position by managing the effects of PBS Reforms effectively with pharmacists. API opened a new distribution center in Western Australia, for $5 million, to help deliver more timely and efficient stock management for addressing their rising customer base in that state. They also enhanced investment in the development of professional services for stores as this area. On the other side, the group is waiting for the result of the Government’s review of pharmacy remuneration and regulation, and has worked with the industry’s peak body, the National Pharmaceutical Services Association, to represent a sustainable position for the sector. As per their New Zealand manufacturing performance, the business showed improvements in the second half of the year as a result of new manufacturing contracts, but overall sales declined by 5.4% and gross profit by 6.8% during FY17 on a yoy basis. However, the group forecasts that their improving earnings performance experienced during the second half of FY17 would be sustained during FY18.
 

Pharmacy Distribution performance (Source: Company reports)
 
Outlook: The group is aiming to continue to enhance their Priceline Pharmacy network while their Pharmacy Distribution business would be stable. Given the tough market conditions in both retail and pharmaceutical distribution, the group continues to focus on optimal retail offer for their Priceline Pharmacy customers. They continue to generate operational improvements as a result of their major capital investments in earlier years. The group is targeting to capture the health and beauty market in Australia via making differentiated offers for mass markets. They are ensuring the customer proposition via delivering a profitable growth. API is also on track with their business strategy of delivering organic growth and focusing on core assets, especially the product and service offering for their store customers. The group spent $26.5 million in FY17 for new and refurbishing stores and is aiming to maintain similar levels in FY18.
 
Stock performance: The group was able to improve their network in FY17 despite tough retail conditions showing their brand strength. They are targeting for more than 20 new Priceline Pharmacies during the upcoming year to expand their penetration and leverage their brand strength. For FY17, they even enhanced their productivity by increasing the in-stock position by 220 basis points against last year. A-lines in-stock improved 300 basis points. For their New Zealand business, Codeine rescheduling required new sales activity to form a stronger manufacturing pipeline during the year. OTC focus has seen a spike in manufacturing contracts for major Australian clients in cold & flu and analgesic products. The group sees positive developments in small-scale exports outside Australia and forecasts a better second half as full value of new contracts is realized for winter/spring 2018. As per the stock performance, API stock lost over 25.7% in this year to date (as of December 01, 2017) at the back of decreasing consumer spending. But the stock has been consolidating for the last three months and delivered over 4.4% returns, while we believe there is more upside momentum. The group delivered a stable FY17 performance despite tough retail conditions and is expected to continue to strengthen their brand and deliver on performance. API also has a decent return on equity and assets that indicate management’s ability and company’s potential on yielding value. Trading at a good dividend yield, we give a “Buy” recommendation on the stock at the current price of $1.56


API Daily Chart (Source: Thomson Reuters)

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