Stick With Shoppers

Shoppers Drug Mart (TSX:SC), one of this country’s most recognized retailers, had 5% or so carved from its market capitalization on Friday.  The market was reacting to news that provincial governments agreed to cap the price on six of Canada’s most popular generic drugs at 18% of the equivalent brand name price.  Prior to this announcement, these generic drugs had sold at 25-40% of their branded equivalents.

The move is a cost saving measure for the provinces, who along with private health plans, account for a very large majority of prescription drug purchases in Canada.  It is expected that the cap will save the provinces about $100 million per year and of course negatively impact pharmacies by a similar amount.

A drop in the shopping cart

Shoppers had combined revenues of $10.7 billion over the past four reporting periods.  Even if it filled every prescription in the country, a $100 million annual hit is hardly material and therefore unlikely to be the reason for the January 18^th decline.  The decline can more likely be attributed to the reintroduction of headline risk for Canadian pharmacies and the possibility that further announcements could turn this $100 million into a much bigger number.

The industry, and Shoppers’ shares, faced a considerable headwind in the spring of 2010 when the province of Ontario announced a sweeping reform to its drug system.  The news cut Shoppers earnings multiple from the 16-17 range that it had been trading in to 13.  Although regulatory risk has been an undertone since the 2010 Ontario decision, Shoppers multiple had drifted back into the range of 15.  The recent announcement served as a reminder that the provinces remain a risk to this story and a multiple closer to 13 or 14 may be more appropriate for Shoppers at this time.

Keep calm and invest on

For current shareholders, don’t panic.  While these provincial actions are likely to have an impact on the company’s near term growth, longer term it is tough to find a story that makes more sense.  The company is financially sound, pays a nice dividend that has grown steadily, and has great prospects for future growth.  Currently 14.4% of Canadians are 65 and over.  By 2026, this figure is expected to move to 20%.  More than 6 million Canadians will be in their prime (prescription) drug taking years.  There are few Canadian companies as well positioned to play the ageing demographic card as Shoppers.  Once the reform is complete, the combination of pricing certainty and a highly favourable demographic should be very rewarding for long term owners of Shoppers Drug Mart.  This is not a name that you should run away from.

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Fool contributor Iain Butler does not own shares in any of the companies mentioned in this post.  The Motley Fool has no positions in the stocks mentioned above.