Shoppers Drug Mart bucks slowdown

What consumer slowdown? Last week, Shoppers Drug Mart Corp. posted second-quarter results that not only beat Bay Street estimates and rewarded investors for their faith in the stock, but also showed up very well against other major publicly owned drugstore chains in North America.

Same-store prescription sales climbed 6.4 per cent from a year earlier, while the so-called front-of-the-store sales (the non-drug proportion of sales) rose 3 per cent. Vishal Shreedhar, who follows Shoppers for UBS Securities Canada Inc., compared Shoppers' latest numbers with those of Walgreen Co., Rite Aid Corp., CVS Caremark Corp. and Jean Coutu Group (PJC) Inc. and found they are among the strongest in North America.

Rite Aid, for example, saw its drug sales increase just 1.9 per cent in the latest quarter and its front-of-the-store sales increase by just 0.8 per cent.

Shoppers' sales are split almost evenly between drug sales and front-of-store items, with the drug portion having increased from 46.9 per cent a year ago to nearly 48 per cent in the latest period.

Buoyed by strong same-store sales growth, Shoppers' second-quarter profit climbed to 59 cents a share from 52 cents a year earlier, bettering the consensus forecast by a penny.

Investors were impressed by the second-quarter report. So, too, were analysts. Mr. Shreedhar has the shares as a "buy" with a $63 12-month price target. Keith Howlett, who follows the stock for Desjardins Securities, reiterated his "buy" recommendation and $60 target in a report subtitled, "Shoppers cruises along as other retailers struggle." And Irene Nattel, an analyst with RBC Dominion Securities, has Shoppers as a "top pick" with a $66 price target. She said in a report that at its current price, Shoppers is trading at the "very low end of its historical valuation range, which provides a compelling entry point for investors, in our view."

Last Wednesday, the day the numbers came out, Shoppers shares jumped $3.15 or 6.2 per cent, the biggest single-day advance in six years. At yesterday's close of $54 on the Toronto Stock Exchange, Shoppers' shares are up 1.39 per cent year to date, which may seem puny when compared to the 55.4-per-cent surge in Potash Corp. of Saskatchewan for example. But it has managed to beat the S&P/TSX composite itself, and has bested the dismal showing of many other stocks in the index.

So why has Shoppers fared better than the average TSX stock this year and why do investors find it attractive?

Jonathan Wellum, chief investment officer of AIC Ltd., rhymed a list of reasons why he likes the stock. AIC holds the stock in several funds, including the AIC Diversified Canada Fund, and in some private accounts as well. Most of the shares were bought in the low-$20s range shortly after the initial public offering in 2001.

First, he noted that there are only a limited number of strong retail stocks in Canada. Then, there is the fact that Shoppers operates in an area that stands to benefit from an aging population. "Clearly, ... health care needs, prescription drugs and things like that are areas of ... longer-term growth, just with the aging of the population," he said in an interview. So too are cosmetics and beauty items. "So you have a sector that does have some wind to its back."

Add to that the convenience factor - nice locations, easy to get in and out of, urban settings, increasing square footage and good management, he said.

"It is ... a unique, well-run Canadian brand in the right space at the right time exploiting certain market segments in Canada where the competition is quite weak."

Shoppers' profit has grown 18 to 20 per cent a year, but Mr. Wellum said he would be happy with 10- to 12-per-cent growth over the next three to five years.

As the current stock price indicates, while investors are clearly impressed with the latest results, there is some worry about just how Shoppers will fare in a slowing economy. Mr. Wellum said a slowdown would clearly have some impact, but it would be, in his view, "very manageable." Demand for a lot of the core products that Shoppers makes most of its money on is relatively inelastic, meaning consumers will put a higher priority on filling a prescription or buying cosmetics that make them feel good than, for example, buying backyard furniture, he said.