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Morningstar | API Gets Skin in the Game; Shares Remain Undervalued

We have taken a fresh look at narrow-moat Australian Pharmaceutical Industries, or API, in light of its acquisition of Clearskincare Clinics, and we maintain our fair value estimate at AUD 1.95 per share. We think the rationale for the acquisition is sound, given the similar demographic segment, women aged between 18 and 50 years, being targeted by the Priceline retail brand in the health and beauty space. At current levels, API shares remain significantly undervalued and reflect, in our opinion, the market's overly pessimistic outlook given the perceived threat of Amazon's online business to health and beauty category sales in traditional retail settings.

We think the skincare acquisition is attractive given the comparatively higher 30% EBITDA margin of the target, reflecting the specialised nature of the service offering, compared with API group EBITDA margins of around 3% in first-half 2018, and consider the deal reasonably priced given an 8.9 EBITDA multiple. This is around the typical 7-9 EBITDA multiple range of deals in the broader healthcare sector and is based on a total cost of AUD 127.4 million and forecast EBITDA of AUD 14 million for fiscal 2019 as guided by management. This increases our forecast EBITDA for fiscal 2019 by 11% to AUD 136 million and increases forecast fiscal 2019 EPS by AUD 0.02 to AUD 0.14. In the medium term, the acquisition lifts our three-year CAGR EBITDA forecast at the group level to 1.9% from 1.4%.

API's balance sheet remains in good shape. After incorporating a new medium-term debt facility of AUD 65 million, debt/adjusted EBITDA remains a comfortable 0.82. As such, and with payments staggered over a three-year period, we remain comfortable with API's ability to service its debt.

Clearskincare Clinics specialises in laser hair removal, assorted skin treatments, and cosmetic injectables with 42 clinics in high-traffic metro locations in Australia and two clinics in New Zealand. We expect growth of Clearskincare to be driven largely via franchising and model the addition of two clinics per year in our base case, representing a four-year CAGR of 3%. This is broadly in line with the growth trajectory achieved by the vendors since inception in 2005.

Although we think the acquisition is attractive and provides a new platform for growth over the longer term, our narrow moat rating, based on efficient scale associated with its pharmaceutical wholesaling and distribution business, is intact given the still-high exposure to the Pharmaceutical Benefits Scheme-derived revenue.