Dis-Chem Pharmacies | Inflection point

Direct and indirect costs from two consecutive strikes over the last two years will leave DCP's FY '20 earnings on FY '17 earnings despite the Group growing revenue by c.13% pa. Adjusting for the once-off impacts, we estimate the Group would have grown earnings in line with revenue. This is despite low inflation and the additional costs from aggressive store expansion constraining margins. In our view, the Group's earnings trajectory is normalising. DCP's store expansion is moderating and maturing trading densities will contribute to a four-year revenue CAGR of c.14%. According to our estimates, revenue growth should increase cumulative margin expansion by 40bps to c.6%, supporting 18% earnings CAGR to c.145cps in FY '23. On this basis, Group ROIC will improve from 18% to c.25.
Management has guided that all strike action is now in the past. Cumulatively we estimate the cost of the strike at ZAR R94m. We estimate H2 '20 earnings will grow by 20% y/y, marking the inflection point of the Group's growth prospects. We forecast inflation to double y/y to c.2.4% in FY '20, with further acceleration to c.3.5% over the next two years due to a c.5% increase of the single-exit drug price (SEP) over the next 12m. Approximately c.36% of DCP's c.169 stores are yet to reach full maturity as at FY '20. We calculate DCP's new retail store trading densities quadruple over a four-year maturation period, which supports operating leverage.
DCP trades at a c.18% PE discount to Clicks (CLS) despite a stronger growth pipeline, due to the recent inconsistency of its growth and governance concerns. A structurally lower ROIC from DCP's big-box format versus CLS's convenience formats also explains DCP's rating discount. We believe that with the delivery of its growth potential over the next year, DCP's current share rating will hold.
We calculate a 12m TP of R30/share for DCP and maintain an OUTPERFORM rating.