EUR 850.00 For Business Accounts Only

Morningstar | Transfer of Analyst Coverage on Australian Pharmaceutical Industries

We have transferred analyst coverage of narrow-moat-rated Australian Pharmaceutical Industries, or API. We maintain our current forecasts and our AUD 1.95 per share fair value estimate. Shares in Australian Pharmaceutical Industries are currently trading 14% below our intrinsic assessment.

Our long-term view on the pharmaceutical distribution business remains cautious. We expect earnings growth in this segment to be under pressure, given current government Pharmaceutical Benefits Scheme, or PBS, policies, and potential risk from major pharmaceutical companies distributing directly to pharmacies outside the regulated wholesale system. API remains highly leveraged to the Australian pharmaceutical wholesale market, with 72% of revenue and half of gross profit generated from this space in fiscal 2017. We maintain our forecast for five-year revenue CAGR of 1.5% for the division, reflecting the underlying growth of the PBS.

API's Priceline Pharmacy brand provides a differentiated offering to community pharmacies, seeking to offset PBS decline with higher retail sales. Priceline’s product range extends to health and beauty lines, in addition to traditional pharmacy products. However, this also exposes API to competition from grocery, specialist retailers, discount department stores, and other potential disruptors with online offerings. Despite increasing competition, API's retail offering provides synergies with the traditional pharmacy-focused model and adds to the operating leverage of the distribution business. We also expect diversification into non-PBS-related revenue to support margin improvement. The retail division, for example, accounted for only 28% of revenue but generated half of gross profit in fiscal 2017.

Over the medium term, we see Priceline's pricing power and sales growth supported by customer-engagement strategies such as the expanded Sister Club loyalty program relaunched in early 2017, increasing focus on product offerings exclusive to Priceline, and improving product mix. Our longer-term like-for-like store sales growth assumption of 2% is unchanged and is based on the bottom end of the Reserve Bank of Australia's long-term inflation range. Although retail gross margins trended lower to 21% in fiscal 2017 from 24% back in fiscal 2014, we think the above-mentioned initiatives should support margins near 21% over the medium term.

Besides front-of-store sales growth, expansion of the Priceline Pharmacy network remains a key strategic priority. Management has on average delivered around 23 new pharmacies per year for the past five years, modestly above the target of 20 stores per year. We view the Priceline Pharmacy franchise value proposition as attractive versus independent pharmacies faced with a challenging regulatory environment and the ongoing impact of PBS reform. We forecast an additional 20 stores will be added annually for the next five years, bringing total franchisee-owned stores to 437 by 2022.