Roadmap for Consolidation Initiating Coverage

Transcription

EQUITY RESEARCH
Pharmacies
June 13, 2013
Roadmap for Consolidation
Initiating Coverage: PFRM3 Is Our Top Pick
We are initiating coverage of the top three Brazilian Drug Retail and Distribution sectors
stocks. It is hard to imagine a sector where the three leaders have such a different
strategy, stage of development, return profile and ownership culture. We look at their
major operating challenges as they integrate major acquisitions, enhance their organic
growth capability and prepare for more deals. With the consumer stalling and same
store sales growth pausing for the industry, we argue that the quality of management,
geographic footprint and quality of operations will be crucial to generate strategic
value for the companies in the next consolidation round of the Brazilian market. In sum,
this is a sector that for all of its massive M&A over the past three years still has room
for operating improvement and its biggest deals ahead.
Profarma (PFRM3 BZ), with a 45% upside is rated Overweight. The stock trades at
book value, and at 7x EV/EBITDA it carries half the valuation of its strongest peer.
Profarma is in the early stages of a transformational shift from distribution company
to drug retailer. But transformational success is not priced in per our DCF of this
“show me” stock. The other two stocks are rated Equal Weight. We like Raia Drogasil
(RADL3 BZ) for the quality of its two established retail brands, industry leader position,
seasoned management team and strategic value to an international buyer. But the
stock’s 17% upside on an intrinsic value analysis holds us back. Brasil Pharma (BPHA3
BZ) was created in 2009 as a roll-up vehicle. It has a 22% upside and several operating
challenges in trying to integrate all of its acquisitions. At an 11x 2014E EV/EBITDA
multiple it is not cheap, but could be attractive to foreign industry participants.
Roadmap for Consolidation. With 50% of the national drug retail sales still in the
hands of independent players, there are local M&A opportunities ahead. But large
international drug retailers like CVS have been late to arrive and other major players
may have interest in acquiring one of these three Brazilian leaders. We thus evaluate
the drug retailers balancing a fundamental analysis and the strategic value of the assets
in the consolidation process, which is reflected in our bull case scenario.
Profarma is our top pick. We like companies transitioning to a new business model
not understood by the market, particularly when elements of success start to make
themselves evident and so much operating improvement is ahead. Profarma’s discount
to peers is related to Profarma’s low stock liquidity, challenges in its distribution
business, low profit margins, and market doubts that its plan to become a premier drug
retailer will succeed. We discuss how management’s operating, financial and strategic
plans are proceeding. We project a 5-year EBIT growth rate of 22% and a margin
expansion from 2.6% to 3.2%. A ROIC of 11% is already at the top of its peer group.
We believe that Profarma will be able to carry on the consolidation of smaller players
while competitors are busy managing the integration of their operations. Financially,
management does not seem averse to raising capital in the equity markets to relieve
its liquidity issue and deploy fresh capital for a major growth initiative.
RADL3 | Drug Retail
Stock Rating: EQUAL WEIGHT
YE14 Target Price: R$25.0/share
Upside/Downside: 17%
Market Cap (R$ billion): 7.1
BPHA3 | Drug Retail
Stock Rating: EQUAL WEIGHT
PFRM3 | Distribution / Drug Retail
Stock Rating: OVERWEIGHT
Guilherme Assis
[email protected]
55 11 3206 8285
Ruben Couto
[email protected]
55 11 3206-8281
Brasil Plural Corretora does and seeks to do business with companies covered in its reports. As a result, investors should be aware that the company may have a
conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment
decision. For analyst certification and other important disclosures, refer to the Disclosure Section on page 54 of this report.
Healthcare | Roadmap for Consolidation
June 13, 2013
Table of Contents
Investment Summary .................................................................................. 3
Profarma: Overweight Rating and YE14 TP of R$24 (Top-pick) ....................... 3
Raia Drogasil: Equal Weight Rating and YE14 TP of R$25................................ 3
Brasil Pharma: Equal Weight Rating and YE14 TP of R$13 .............................. 4
Roadmap for Consolidation ......................................................................... 7
PFRM3: The New Kid on the Block; Still Valued as a Distributor ..................... 8
RADL3 Stands Out as the Best Asset in the Country........................................ 9
BPHA3: A True Consolidation Play, but Integration Is a Risk ........................... 9
Private and Off the Radar Companies Complete Our List ............................... 9
Standing on the Shoulders of Giants ............................................................. 11
Consolidation Through a Looking Glass ......................................................... 13
Can Profarma Be the Next Consolidator? ...................................................... 15
Global Trends: Moving Towards an Integrated Model .................................. 16
Valuation .................................................................................................. 19
Earnings Outlook and Intrinsic Valuation ...................................................... 19
Intrinsic Value Debate: Assessing the Value of Synergies ............................. 21
Profarma ........................................................................................................ 23
Raia Drogasil .................................................................................................. 25
Brasil Pharma ................................................................................................. 27
Historical Valuation Multiples........................................................................ 29
Main Risks ................................................................................................. 30
Industry Comps ......................................................................................... 31
News From the Operating Front ................................................................. 33
Profarma ........................................................................................................ 33
Raia Drogasil .................................................................................................. 39
Brasil Pharma ................................................................................................. 44
Appendix: Key Industry Themes ................................................................. 51
Secular Trends Underpin Pharma Growth on Steroids.................................. 51
Brasil Plural Equity Research | 2
June 13, 2013
Investment Summary
In this section we present a summary of the main figures, positives and negatives from
all covered companies.
Profarma: Overweight Rating and YE14 TP of R$24 (Top-pick)
We welcome Profarma’s recent strategic shift moving from a pure distributor to a
hybrid model of distribution and drug retailing. We view Profarma as a business in
transition that may yield significant results if executed properly, and one that would
become an appealing asset to major domestic or international drug retailers. Thus, we
rate Profarma as Overweight and as our top-pick, chiefly due to its attractive 45% DCF
upside potential, based on a growing magnitude of retail operations (36% and 58% of
total gross revenues and total EBITDA, respectively, by 2017). According to our
estimates, PFRM3 trades at a 20% NTM P/E historical discount to RADL3 and BPHA3 in
light of uninspiring earnings outlook from the distribution segment. This said, although
we do not expect Profarma to evolve into the leading drugstore chain in Brazil, its
exposure to retail should drive its valuation multiples to a narrower discount to drugretailers and above the 1.0x P/BV threshold.
Chart 2: Profarma Main Positives and Negatives
Positives
Negatives
(+) Substantial operating performance
improvement from retail operations
(-) Lack of experience in retail
(+) Superior working capital structure in
the distribution-retail hybrid model
(-) Short-term operating performance
should remain bleak until retail gets
critical mass
(+) Plenty of room to consolidate the
small-medium drugstore chains market
(-) Weak balance-sheet
Source: Brasil Plural Research
Raia Drogasil: Equal Weight Rating and YE14 TP of R$25
From a strategic perspective, Raia Drogasil stands out as the glaring example of
successful drug retail enterprise, combining strong execution capabilities and powerful
brands. The company enjoys the best drug retail locations in São Paulo and the best
operations among its listed peers. In our view, the acquisition of Raia Drogasil by an
international drug retailer would provide a full-speed ticket to ride Brazil’s
“pharmerging” potential. However, we rate Raia Drogasil as Equal Weight, mainly
driven by its 17% DCF upside potential, at what we believe are realistic assumptions
(we assume 300bps EBITDA margin expansion, to our estimated 8.0% steady state
margin). Despite Raia Drogasil’s operating prowess, we find YE14 P/E multiple of 25x –
38% above historical levels -- highly demanding, which already prices in our expected
25% EPS CAGR during 2013-2016.
Chart 3: Raia Drogasil Main Positives and Negatives
Positives
Negatives
(+) Management with deep industry
knowhow
(-) Integration hurdles curb synergy gains
(+) Leading position in top markets
(-) Growth hinges on aggressive expansion
plan
(+) Benchmark operating performance
(-) Exposed to highly competitive regions
June 13, 2013
Brasil Pharma: Equal Weight Rating and YE14 TP of R$13
Brasil Pharma is in a stage of development where it left the spot of “potential target”
to rise as one of the industry’s prime consolidators. We believe the company’s regional
powerhouses could unlock a great opportunity for international players that are
pursuing to tap the attractive markets outside the southeastern cone.
Notwithstanding, we rate Brasil Pharma as Equal Weight as its integration hurdles still
restrain the company’s full potential, and the 23% DCF upside based on synergy gains
is overshadowed by relatively higher execution risks (we estimate 200bps EBITDA
margin expansion, to our estimated 7.4% steady state margin). In addition, BPHA3’s
YE14 P/E multiple of 16x, trading at 35% discount to RADL3 – is hardly a bargain and
reflects most of our estimated 35.1% EPS CAGR during 2013-2016.
Chart 4: Brasil Pharma Main Positives and Negatives
Positives
(+) High exposure to less competitive
markets
(+) Strong M&A execution capability
(+) Call option on large franchise system
in the southeastern market
Negatives
(-) Integration poses ongoing risks
(-) Decentralized operations may increase
execution risks
(-) Potential dilution on share-swap deals
Chart 5: Operating Comp Numbers
Main Figures
Operating Metrics (Drug Retail)
Number of stores (EoP)
New stores (EoP)
Avg. Monthly Gross Sales per Store (R$'000)
Same-store-sales (SSS)
Income Statement (R$million)
Gross Revenues
Net Revenues
Gross Profit (Incl. Other Operating Income)
SG&A
EBIT
EBITDA
Financial Results
Net Income
Balance Sheet (R$million)
Total Assets
Cash & Equivalents
Inventory
Receivables
PP&E (ex-intangibles)
Total Liabilities
Suppliers
Total Debt
Shareholders' Equity
Ratios
Gross Margin (% of gross sales)
EBIT Margin (% of gross sales)
EBITDA Margin (% of gross sales)
Net Margin (% of gross sales)
Debt/Equity
Net Debt/EBITDA
Cash Cycle (days)
Raia
Drogasil
2012A
Brasil
Raia
Profarma
Pharma
Drogasil
864
88
547
11.5%
708
80
440
14.2%
n.a.
n.a.
n.a.
n.a.
5,594
5,381
1,494
(1,168)
216
326
(3)
154
3,094
2,876
944
(778)
103
166
(46)
17
3,340
167
973
336
454
1,076
576
192
2,265
26.7%
3.9%
5.8%
2.8%
8.5%
0.1x
58.5
2013E
Brasil
Raia
Profarma
Pharma
Drogasil
977
113
571
8.5%
788
94
382
9.9%
3,803
3,233
205
(257)
84
92
(29)
40
6,556
6,312
1,772
(1,362)
270
410
(9)
220
2,903
369
552
214
181
1,360
335
776
1,543
1,431
49
426
551
34
860
515
223
561
30.5%
3.3%
5.4%
0.5%
50.3%
2.5x
65.4
5.4%
2.2%
2.4%
1.1%
39.7%
1.9x
41.5
2014E
Brasil
Raia
Profarma
Pharma
Drogasil
147
147
377
n.a.
1,100
123
599
8.4%
888
100
418
8.8%
3,667
3,430
1,100
(883)
162
217
(38)
113
4,395
3,816
324
(355)
80
112
(47)
25
7,759
7,465
2,131
(1,607)
364
524
(12)
285
3,657
183
1,084
392
546
1,320
677
180
2,337
2,930
191
594
260
240
1,299
369
597
1,631
2,249
509
480
609
221
1,256
586
540
980
27.0%
4.1%
6.3%
3.4%
7.7%
0.0x
53.7
30.0%
4.4%
5.9%
3.1%
36.6%
1.9x
60.2
7.4%
1.8%
2.6%
0.6%
55.1%
0.3x
38.9
2015E
Brasil
Profarma
Pharma
322
175
452
n.a.
1,223
123
625
8.5%
988
100
445
9.7%
497
175
452
9.1%
4,471
4,203
1,332
(1,043)
227
289
(26)
172
5,624
4,932
577
(547)
100
183
(62)
23
9,060
8,716
2,498
(1,858)
456
640
(25)
341
5,333
5,013
1,596
(1,223)
304
373
(19)
228
6,877
6,081
854
(752)
139
263
(68)
47
4,117
274
1,273
461
636
1,694
780
357
2,423
3,131
178
703
313
274
1,371
440
554
1,760
2,396
162
593
768
391
1,380
751
489
997
4,638
408
1,477
536
723
2,131
905
582
2,508
3,384
204
822
371
305
1,453
520
509
1,931
2,731
43
714
880
551
1,673
905
610
1,032
27.5%
4.7%
6.8%
3.7%
14.7%
0.2x
55.5
29.8%
5.1%
6.5%
3.8%
31.5%
1.3x
59.9
10.3%
1.8%
3.2%
0.4%
49.0%
1.8x
36.1
27.6%
5.0%
7.1%
3.8%
23.2%
0.3x
55.3
29.9%
5.7%
7.0%
4.3%
26.4%
0.8x
58.4
12.4%
2.0%
3.8%
0.7%
59.1%
2.2x
32.9
Source: Companies and Brasil Plural Research
June 13, 2013
Chart 6: Selected Companies Valuation Multiples
2013E
P/E
2014E
2015E
2013E
EV/EBITDA
2014E
2015E
Fw 3-Year CAGR (%)
SALES
EBITDA
EARNINGS
25.0
13.0
24.0
32.2x
24.2x
37.1x
31.2x
24.8x
15.9x
39.8x
26.8x
20.8x
12.0x
19.6x
17.5x
17.3x
14.4x
8.4x
13.4x
13.7x
10.8x
6.8x
10.4x
11.3x
8.1x
5.6x
8.3x
17.3%
18.4%
21.4%
19.0%
24.6%
26.6%
43.2%
31.5%
25.0%
35.1%
53.9%
38.0%
NA
NA
NA
15.6x
15.4x
17.0x
16.0x
14.3x
14.0x
11.6x
13.3x
13.0x
13.2x
9.8x
12.0x
8.2x
9.0x
7.3x
8.2x
7.6x
8.2x
6.6x
7.5x
7.1x
7.6x
5.9x
6.9x
5.9%
5.4%
NA
5.7%
7.4%
18.9%
7.5%
11.2%
8.5%
18.6%
NA
13.5%
NA
NA
NA
13.9x
13.4x
17.5x
14.9x
12.8x
13.7x
14.9x
13.8x
11.8x
12.5x
13.4x
12.5x
8.2x
8.2x
9.2x
8.5x
7.3x
7.4x
7.9x
7.5x
6.6x
6.7x
7.0x
6.7x
1.3%
-5.5%
9.6%
1.8%
8.2%
4.5%
14.8%
9.2%
10.2%
5.4%
16.6%
10.7%
Global Peers - Integrated Drug Retailers / Distributors
Celesio
15.8
NA
Dimed/Panvel
248.0
NA
Casa Saba
7.8
NA
Average
12.3x
NA
NA
12.3x
10.8x
NA
NA
10.8x
9.7x
NA
NA
9.7x
7.2x
NA
NA
7.2x
6.5x
NA
NA
6.5x
5.9x
NA
NA
5.9x
1.7%
NA
NA
1.7%
5.3%
NA
NA
5.3%
11.4%
NA
NA
11.4%
Retail Peers - Brazilian Retail
Lojas Americanas
B2W
CBD
Dufry
Guararapes
Lojas Renner
Cia. Hering
Marisa
Les Lis Blanc
Alpargatas
Arezzo
Grendene
Tecnos
Average
29.3x
NA
21.4x
NA
12.5x
20.1x
16.4x
14.3x
26.8x
14.8x
23.2x
13.7x
21.8x
19.5x
22.0x
NA
17.9x
NA
10.0x
17.3x
14.1x
11.8x
18.6x
13.0x
18.7x
12.4x
14.7x
15.5x
16.7x
NA
15.2x
NA
8.3x
14.7x
12.2x
9.8x
14.9x
10.0x
15.3x
11.5x
12.5x
12.8x
10.0x
7.2x
7.6x
NA
7.2x
11.1x
11.5x
7.8x
10.1x
NA
16.3x
12.3x
16.5x
10.7x
8.3x
6.9x
6.6x
NA
5.9x
9.6x
9.6x
6.4x
8.1x
NA
12.5x
10.8x
12.2x
8.8x
6.9x
5.8x
5.6x
NA
5.0x
8.2x
8.2x
5.6x
6.9x
NA
10.2x
9.6x
9.7x
7.4x
14.2%
8.3%
10.9%
NA
NA
16.3%
13.1%
10.5%
25.2%
NA
18.8%
NA
11.5%
14.3%
NA
NA
14.1%
NA
NA
17.4%
16.1%
13.3%
17.5%
NA
24.1%
NA
22.2%
17.8%
32.2%
NA
17.2%
NA
NA
18.1%
15.6%
15.9%
49.9%
NA
22.0%
NA
32.1%
25.4%
Last Price
Company
(Local Curr)
Drug Retail and Distributoion
Raia Drogasil
21.5
Brazil Pharma
10.7
Profarma
16.5
Average
Global Peers - Drug Retail
CVS
Walgreens
Rite Aid
Average
Target Price
(Local Curr)
59.3
50.1
3.2
Global Peers - Drug Distribution
McKesson
113.9
Cardinal
47.9
AmerisourceBergen
54.6
Average
15.6
7.9
98.7
283.0
92.0
69.5
34.5
24.0
8.2
14.5
35.3
20.4
19.7
NA
NA
NA
121.0
82.0
43.0
38.0
9.0
NA
NA
NA
NA
NA
Source: Bloomberg and Brasil Plural Research
D
June 13, 2013
Chart 7: Selected Companies Share Performance
Company
Avg Daily
Market Cap
Trad. Vol
(USD mn)
(USD mi)
Rating
Last Price
(Local
Currency)
Target
Price
(R$)
Upside/
Downside
13-Jun-13
Drug Retail and Distributoion
Raia Drogasil
Brazil Pharma
Profarma
Average
52 Week Range
(Local Currency)
High
Low
Share Performance (%)
1 Week
1 Mth
3 Mth
12 Mth
YTD
3,343
1,281
262
10.8
5.6
1.8
EW
EW
OW
21.5
10.7
16.6
25.00
13.50
24.00
16.6%
26.4%
44.7%
24.6
15.7
25.1
18.6
9.3
9.5
-7.4%
-12.5%
-4.4%
-5.6%
-17.7%
-22.8%
-8.8%
-27.1%
-10.3%
10.1%
10.4%
56.5%
-6.9%
-26.4%
14.4%
Global Peers - Drug Retail
CVS
Walgreens
Rite Aid
Average
72,570
47,441
2,849
161.1
141.1
26.5
NA
NA
NA
59.3
50.1
3.2
NA
NA
NA
NA
NA
NA
60.7
51.3
3.2
38.4
43.7
28.5
1.0
24.4
2.4%
3.8%
8.6%
4.9%
1.2%
2.0%
23.5%
8.9%
12.0%
17.0%
80.0%
36.4%
31.2%
62.1%
169.2%
87.5%
22.6%
35.3%
131.6%
63.2%
Global Peers - Drug Distribution
McKesson
Cardinal
AmerisourceBergen
Average
25,800
16,373
12,598
66.7
79.7
74.3
NA
NA
NA
113.9
47.9
54.6
NA
NA
NA
NA
NA
NA
119.3
48.4
56.9
74.9
84.7
36.9
36.4
52.6
1.8%
3.8%
3.8%
3.2%
-0.7%
3.8%
0.1%
1.1%
2.9%
2.3%
11.7%
5.6%
28.4%
15.3%
49.7%
31.1%
17.4%
16.3%
26.4%
20.0%
Global Peers - Integrated Drug Retailers / Distributors
Celesio
3,588
3.7
Dimed/Panvel
522
0.1
Casa Saba
203
0.0
Average
NA
NA
NA
15.8
248.0
7.8
NA
NA
NA
NA
NA
NA
16.8
307.5
11.4
111.9
11.4
135.0
4.9
50.4
-0.7%
-0.8%
0.0%
-0.5%
2.8%
-8.2%
-1.9%
-2.4%
14.1%
-14.2%
-4.8%
-1.6%
36.0%
77.3%
-26.8%
28.8%
20.9%
-11.4%
-23.5%
-4.7%
Retail Peers - Brazilian Retail
Lojas Americanas
B2W
CBD
Dufry
Guararapes
Lojas Renner
Cia. Hering
Marisa
Les Lis Blanc
Alpargatas
Arezzo
Grendene
Tecnos
Average
NA
NA
NA
NA
EW
EW
EW
OW
UW
NA
NA
NA
NA
15.5
8.0
98.6
283.0
92.0
69.5
34.5
24.0
8.2
14.6
35.4
20.4
19.7
NA
NA
NA
NA
121.0
82.0
43.0
38.0
9.0
NA
NA
NA
NA
NA
NA
NA
NA
NA
18.1%
24.8%
58.3%
9.6%
NA
NA
NA
NA
27.7%
19.6
19.9
115.6
300.0
128.0
82.0
48.7
33.8
11.4
15.7
45.0
23.7
26.9
46.1
12.0
5.4
73.5
232.0
82.0
52.5
33.7
19.6
7.9
10.6
27.0
9.9
16.0
28.8
-4.9%
-16.1%
-6.4%
-1.3%
-7.3%
-3.9%
-6.6%
-13.4%
-4.0%
-2.6%
-3.0%
-1.3%
-1.1%
-4.8%
-8.7%
-24.6%
-9.5%
3.3%
-10.5%
-7.5%
-17.3%
-18.1%
-8.4%
3.3%
-13.7%
-8.8%
-14.0%
-10.5%
-16.1%
-53.1%
-7.6%
7.7%
-16.5%
-5.2%
-12.6%
-23.8%
-13.6%
14.5%
-11.6%
-4.5%
-22.7%
-10.7%
27.1%
32.8%
30.4%
14.5%
6.7%
16.2%
-20.9%
-3.0%
-25.0%
25.8%
23.8%
100.1%
23.1%
16.3%
-14.9%
-53.1%
9.1%
3.1%
-24.4%
-12.6%
-18.2%
-26.2%
-13.8%
5.8%
-10.5%
24.3%
-21.2%
-10.8%
36,077.1
26,209.1
-4.00%
-3.28%
-4.76%
-22.96%
-6.22%
7,057
588
12,284
3,923
2,585
4,104
2,659
2,097
666
2,707
1,477
2,904
723
Index
IBOVESPA
17.1
4.1
45.6
3.1
0.8
33.9
27.9
5.2
2.0
2.6
4.8
5.6
3.6
June 13, 2013
Roadmap for Consolidation
The next round of the consolidation of drug retailers in Brazil is ongoing -- recent
moves outside the country have blurred the line that divides retail and distribution
on a global scale, and the entry of CVS in Brazil indicates more moves ahead. We
thus evaluate the drug retailers balancing a more fundamental analysis, as well as
the strategic value of assets in a possible consolidation process. In addition to secular
growth drivers for the industry and how each of the players are positioned to benefit
from this growth potential, we also take into account a more strategic approach on
what will be their role in the final round of consolidation. In our view, the key variable
metrics that will drive long-term value for drug retail stocks are:
Footprint: The geographic exposure of companies will be an important value driver
for drug retailers, both in terms of fundamentals and attractiveness in the
consolidation process. In the case of fundamentals, we believe that the footprint
will influence in each company’s organic growth and value as an acquisition target.
From the consolidation standpoint, we believe that the overall footprint will define
the appeal of the asset for the international players that want to have a sizeable
operation in Brazil.
Scale: Drug retail is a scale business, and the bigger the sales, the greater the
bargaining power and the greater the possibility to go direct or squeeze
distributors. The drug market in Brazil has regulated prices, but large retail chains
buy at higher discounts than small, independent mom and pop stores, giving them
a competitive edge that will become more evident as the drug retail market
becomes more formal. As a result, we believe that scale will be an important driver
for gross margin and potential growth.
Competitive Pressure: Relates to each player’s geographic exposure and the level
of concentration of the retailers in any given region, as well as the market
positioning more towards the top or the bottom of the social-economic pyramid. In
our view, competitive pressure will drive each company’s pricing power, and
companies with large scale and lower competitive pressures will be able to operate
with higher gross margins.
Sales Mix: Arguably the main driver for gross margin of drug retailers, as margins
vary significantly among the different product categories. Despite relatively lower
prices, generics present much higher margin than branded and OTC products, as
drugstore chains don’t have to carry all the brands on their shelves and sales
depend on the suggestion of the pharmacist and the sales clerk. As a result, the
gross margin from generics is more than double the margin of the other products,
and the dollar contribution per sale may be higher than branded products, despite
the lower price (see Chart 92, page 51).
Operating performance: Relates to best practices in retail operations and plays an
important role in SSS growth and EBITDA margin of the companies. In our view,
companies that are more integrated will have higher strategic value and would
likely earn a premium in the final round of consolidation.
Balance sheet: in our view, a strong balance sheet is crucial to take advantage of
the consolidation and organic growth opportunities that still exist in the market.
Quality of management: Helps minimize execution risks.
In Chart 8, we compare the three companies we cover plus three other important
players according to key industry drivers mentioned above, ordered by relevance for
future growth.
June 13, 2013
Chart 8: Order of Preference According to Key Industry Drivers
Source: Brasil Plural Research.
Excellent
Satisfactory
Weak
PFRM3: The New Kid on the Block; Still Valued as a Distributor
Profarma is the only drug distribution and retail company that still retains some
significant discount to intrinsic valuation. The company lags behind peers in many of
the key value drivers for the drug retail industry. However, it is telling signs that it is
moving to “next frontier thinking” while it is still regarded by The Street as saddled
with yesterday’s problems, which helps justify the company’s cheap valuation.
Profarma still ranks low in our selected industry drivers, as the company just entered
the retail market -- ranking a lackluster fifth. The main obstacles for Profarma’s
positioning are: 1) its limited footprint, 2) the high competitive pressure in Rio de
Janeiro; 3) its low operating performance; and 4) a leveraged balance sheet. Yet,
Profarma’s positioning should improve significantly as it promotes the turnaround in
Drogasmil operations and continue with its consolidation strategy. In our view,
Profarma’s relationship with small drugstore chains and mom and pop shops on the
distribution side gives the company an advantage to look for potential acquisition
targets, and the integration of distribution and retail could lead to additional gains in
operations as the company can rationalize its working capital requirements. However,
the company continues to trade at a discounted valuation, dragged down by the low
stock liquidity and its challenged distribution business. Even though we see some
important execution risks, we believe Profarma is trading well below its intrinsic value,
and risk-reward is skewed to the upside. Finally, we believe that the valuation gap to
peers should narrow with increased stock liquidity following a potential equity offering
to fund any additional acquisitions and would help improve Profarma’s balance sheet.
June 13, 2013
RADL3 Stands Out as the Best Asset in the Country
Raia Drogasil’s current valuation reflects its premium position and balanced riskreward, particularly from a pure intrinsic valuation standpoint. The main question is
whether it will be up for sale in the final consolidation round. We rank Raia Drogasil
as “best in class” in terms of balance sheet and quality of management, which in our
view will allow the company to take advantage of the national consolidation process.
Raia Drogasil stands to improve its footprint, scale and operating performance even
further, and reinforce its position as the most attractive asset in the next consolidation
round of the Brazilian market. Its current valuation already reflects the quality of the
asset, and we think that the company would trade above current multiples as an
acquisition target in a tender offer to minority shareholders. In our view, any potential
acquirer would have to offer a significant premium to Raia Drogasil’s market value to
convince the controlling shareholders to sell. At the estimated valuation paid by CVS in
the acquisition of Onofre in January 2013 (20x EV/EBITDA – see Chart 12, page 11), we
are not sure that Raia Drogasil’s controlling shareholders would consider selling the
company.
BPHA3: A True Consolidation Play, but Integration Is a Risk
A potential deal for Brasil Pharma would be just the thing for BTG, which created the
company as an M&A play. However, it would have to wait for the full exit of original
founding families that became small shareholders of Brasil Pharma and until
integration progresses further. The company also trades close to its intrinsic value,
but current valuation embeds additional execution risks, related to the quality of the
regional assets. We view Brasil Pharma as the natural consolidation play in Brazil.
Since its inception, the company was created to be a consolidator, focusing on building
a strong platform in the less competitive regions of Brazil. BTG molded it to be a good
fit for any potential player, and succeeded in building the regional platforms which
bodes well in terms of footprint. That said, the company still lacks a consistent
presence in the Southeast, where it currently operates through the Farmais franchisee
brand. In our view, a store network in the Southeast would provide the company
greater scale and firepower to negotiate with suppliers and distributors. This takes
away critical mass, which we believe can be addressed through the buyout of the
franchisees. Due to its higher concentration in the North/Northeast, we rank Brasil
Pharma as the drug retail chain that enjoys the most favorable competitive
environment, presenting the highest gross margin among the listed peers. Despite the
leadership position in its dominant regions, the quality of the assets acquired by Brasil
Pharma varies significantly, taking a toll on the company’s consolidated EBITDA
margins (5.4% in 2012 vs. 5.8% for Raia Drogasil), offsetting the high gross margin
(30.5% in 2012 vs. 26.7% for Raia Drogasil). As a result, the company ranks low in
terms of operating performance. Finally, we believe that management has proven
M&A execution capability. However, the acquisitions have increased the company’s
leverage and we still need more evidence about management’s skill in extracting
synergies from the integration. We still lack visibility on the long-term margin potential
as results still show a lot of non-recurring effects related to the integration process.
Private and Off the Radar Companies Complete Our List
The drug retail industry still encompasses a number of unlisted companies or
companies with very weak ties to capital markets that are off the radar of investors. In
our list, we also evaluate some of the more prominent names, namely DPSP, Pague
Menos, and Dimed/Panvel. DPSP and Pague Menos rank among the top four drug retail
groups in Brazil, with very sound operations.
In our view, DPSP is the only company that rivals Raia Drogasil in terms of quality of
assets. However, the company is currently undergoing a major integration and
restructuring after Drogaria São Paulo (the largest drug retailer in Brazil wealthiest
June 13, 2013
state) merged with Pacheco (the largest one in Rio de Janeiro) to form DPSP. As a
result, the family run company is focused inward and not looking for new M&A
opportunities nor to go public. We believe that once the integration is settled – a two
to-three year process – the company will explore an IPO.
Chart 9: DPSP Operating and Financial Highlights
Drogaria Pacheco São Paulo
(Drug Retailer)
(R$million)
Stores (#)
Gross Sales
Monthly Sales per Store (R$'000)
Gross Profit
Gross Margin
SG&A
EBITDA
EBITDA Margin
Net Income
Net Margin
2012
708
4,975
586
1,349
27.1%
1,057
288
5.8%
151
3.0%
2011
691
4,452
537
1,109
24.9%
912
197
4.4%
82
1.8%
YoY%
2.5%
11.7%
9.1%
21.7%
2.2pp
15.9%
46.5%
1.4pp
83.2%
1.2pp
Source: Company data and Brasil Plural Research
Pague Menos, the only player with a true nationwide footprint, tried to go public in
2012. It boasts very good operations and has presented strong growth over the past
few years, backed by an aggressive and well executed store opening plan that focus
exclusively on organic growth. During the pilot fishing for the IPO, investors showed
concerns with the corporate structure and potential succession issues, as well as with
fiscal incentives granted by the government of Ceará state. Moreover, market
conditions soured and the reception from investors was cold, which forced the
company to shelve its IPO plans. In any case, we believe that Pague Menos will resume
its IPO once market conditions improve.
Chart 10: Pague Menos Operating and Financial Highlights
Dimed
(Drug Retailer and Distributor)
(R$million)
Stores (#)
Gross Sales
Gross Profit
Gross Margin
SG&A
EBITDA
EBITDA Margin
Net Income
Net Margin
2012
292
1,646
470
343
20.8%
274
76
4.6%
47
2.9%
2011
284
1,469
431
290
19.8%
233
64
4.4%
37
2.5%
YoY%
2.8%
12.0%
9.0%
18.0%
1.1pp
17.5%
18.4%
0.2pp
25.9%
0.3pp
June 13, 2013
Finally, the retail/integrated player Panvel, which operates in the South of Brazil, is
the only retailer not under our coverage that trades on the Bovespa. The company
has a R$1.1 billion market cap with a low free float of R$498 million and a dual share
class capital structure, which reflects on the company’s thin average daily volume of
R$350,000 for voting shares (PNVL3) and R$150,000 for the non-voting shares (PNVL4).
Even though Panvel is an important player in the South of Brazil, its founding
shareholders and private equity shareholders have pretty much kept the company off
the radar of the capital markets and do not seem inclined to participate in the
consolidation process.
Chart 11: Panvel/Dimed Operating and Financial Highlights
Pague Menos
(Drug Retailer)
(R$million)
Stores (#)
Gross Sales
Gross Profit
Gross Margin
SG&A
EBITDA
EBITDA Margin
Net Income
Net Margin
2012
585
3,249
463
909
28.0%
700
247
7.6%
107
3.3%
2011
489
2,875
490
718
25.0%
507
232
8.1%
109
3.8%
YoY%
19.6%
13.0%
-5.5%
26.6%
3.0pp
38.1%
6.4%
-0.5pp
-1.6%
-0.5pp
Standing on the Shoulders of Giants
The acquisition of Onofre by CVS may be only the tip of the iceberg, as global players
seek diversification beyond mature markets. In December 2012, CVS announced the
acquisition of Onofre, a 60-store chain with operations concentrated in the city of São
Paulo, but with presence in Rio de Janeiro, Minas Gerais, Espírito Santo and Rio Grande
do Sul. Technically, CVS was not the first international player to make the move into
Brazil -- Chileans and Mexicans tried to enter the Brazilian market in the past without
success, and German integrated player Celesio acquired distribution company
Panarello. However, the entrance of CVS will take the recent consolidation one step
further as the company has much more firepower to carry on the consolidation of the
market, and it could anticipate the entry of other contenders in search of scarce
sizeable assets, looking for strong secular growth drivers of the Brazilian market.
Chart 12: CVS Paid a Toll to Enter in Brazil
According to local newswires,
CVS paid 25x EV/EBITDA or
Onofre, including the online
business.
We assume a normalized
multiple of 20x for the pure
retail operations.
Source: Brazilian Press and Brasil Plural Research
June 13, 2013
Despite its symbolic importance, Onofre is a relatively small asset, with an estimated
R$450 million in sales and operations concentrated in prime areas in the city of São
Paulo. Nonetheless, we believe that CVS is testing the waters and this deal was only a
prelude before it makes a bolder move into Brazil. In our view, if CVS wants to further
increase its operations in the country, it will continue to do so via acquisitions, due to
the difficulties in finding available retail locations and in coping with the complex
cross-state tax structure. Moreover, we believe that the next move will be far more
relevant, as we believe that CVS would likely seek a more diversified operation to gain
critical mass in the country.
Chart 13: CVS Snapshot
Chart 14: Onofre Snapshot
Source: CVS and Brasil Plural Research
Source: Company data, ABRAFARMA and Brasil Plural Research
CVS was the first mover, but we would not rule out other players from joining the
party in Brazil. As a matter fact, Alliance Boots had been wooing local players in the
Brazilian market for a long time -- long before it was acquired by Walgreens -- and we
believe that it may be used as the vehicle for Walgreens to enter the Brazilian market.
Another potential contender to enter the retail market is Celesio, which set foot in the
distribution segment. For some time, we believed that Celesio would not be looking at
retail as it had the chance to acquire Brasil Pharma before the company went public,
but passed on it. However, as the integration of the operations move along, Celesio
may reconsider or analyze other opportunities.
CADE should not be a major concern. CADE has approved all recent deals in Brazil as
the market remains largely fragmented, with the national market share of the largest
players standing below 10% on a standalone basis and less than 20% in some of the
most important markets, such as São Paulo. Altogether, the top four retailers in Brazil
hold approximately 30% of the market, which compares to 85% held by CVS,
Walgreens and Rite Aid in the US. As a result, we think there’s still room for
consolidation as we believe that CADE’s radar for market concentration would only
activate after any single player eclipses 50% market share. Given CADE’s recent
requirements for other industries -- i.e. consumer electronics & hardline retail,
healthcare and education -- we believe that the only drawback in the consolidation
process would be regional concentration, as CADE has been picking on healthcare and
education companies in some of the recent deals. In any case, we believe this would
not prevent the consolidation of the drug retail industry on a higher level.
The only caveat that we foresee for the widespread entry of international players is
regulation. The drug retail market in Brazil is regulated by ANVISA, the National Health
Surveillance Agency, and we would place Brazil in between Europe and the US in terms
the regulation of the drug retail industry. Although drugstore operators in Brazil need a
special license and a full-time pharmacist during all store operating hours, there are no
restrictions for the expansion of drugstore chains in the country, as long as the market
share concentration does not raise any flags at CADE. However, drugstores in Brazil are
only allowed to sell prescription drugs, OTC, CFT and other health-related products,
June 13, 2013
such as medical devices and nutritional supplements. Unlike the US, where drugstores
have converged to a convenience store model, in Brazil they can only sell health and
personal care related products. Despite the restrictions imposed by ANVISA, some of
the players have obtained injunctions from local courts that have liberated them to sell
snack foods -- such as cookies and crackers, chocolates, candy, ice cream, sodas -- and
even other types of products, including home appliances and toys. However, we do not
believe that ANVISA will change its limitations in the short term, thus making it difficult
for US players like CVS to replicate their convenience store model in Brazil.
Chart 15: Products Allowed by ANVISA
Medicine
Medi ci na l products s ubject
to s peci a l control a nd not
s ubject to control ,
medi ci na l pl a nts , herba l
drugs , homeopa thi c drugs
prepa red a nd not prepa red
i n the pha rma cy; ca teri ng
of pha rma ceuti ca l s ervi ces .
CF&T
Food
Other
Cosmetics, perfumes,
toiletries and related
products.
Foods tuff for: di ets wi th
res tri cted nutri ents ,
control l ed i nta ke of
nutri ents , s peci fi c
popul a ti on groups (i .e.
el derl y, chi l dren).
Vi ta mi ns or mi nera l s ,
i s ol a ted or a s s oci a ted
wi th ea ch other.
Ba by bottl es , di a pers ,
pa ci fi ers , ni ppl e s hi el ds
na i l fi l es , cl i ppers , na i l
cl i ppers , na i l s ti cks , cuti cl e
pus hers , combs , brus hes ,
ca ps for ba thi ng, s ha vi ng
bl a des a nd ra zors .
Source: ANVISA and Brasil Plural Research
Consolidation Through a Looking Glass
From a more micro standpoint, Brazilian drug retail took a big leap over the past few
years, undergoing a fast consolidation and formalization process. In 2007, Drogasil
became the first drug retailer in the country to drive investor’s attention when it
completed an offering that repositioned the company in the equity capital markets,
increasing its stock liquidity and the visibility of the industry. Drogasil’s “re-IPO” was
followed by Raia’s IPO in the end of 2009, when the company raised money to improve
its capital structure and speed up its expansion boom. In the meantime, the private
equity arm of the Brazilian finance group BTG created Brasil Pharma, which was set up
to be the main consolidator of the market outside the Southeast region of Brazil,
acquiring operations in the North/Northeast, South and Mid-West. However, the most
transformational deals happened after the IPO breakthrough, with the merger of four
of the top five players into two. The first merger brought together Drogaria São Paulo,
the largest player in São Paulo, and Pacheco, the largest player in Rio, and was
announced in August 2011. The second brought together Raia and Drogasil, creating
the new national leader and the largest drug retailer in São Paulo, with 20% market
share and presence in other 11 states in the Southeast, South and Mid-West of Brazil.
Chart 16: Local M&A Happened Fast…. 12 deals in less than 3 years
Buyer
CVS
Va l e Verde
Profa rma
Profa rma
Bra s i l Pha rma
Bra s i l Pha rma
D. Sã o Pa ul o
Droga s i l
Bra s i l Pha rma
Bra s i l Pha rma
Bra s i l Pha rma
D. Sã o Pa ul o
Bra s i l Pha rma
Pa checo
Target
Value Paid
Stake
Valuation
Date
Onofre
Senador
Tamoio
Casa Saba
Sant'Ana
Big Ben
Pacheco
Raia
Mais Economica
Guararapes
Rosário
Drogão
Farmais
Sta. Marta
R$670mn
N/A
R$43mn
R$87mn
R$497mn
R$454mn
Share-Swap
Share-Swap
N/A
N/A
N/A
N/A
R$9 mn
N/A
80%
N/A
50%
100%
100%
100%
Merger
Merger
N/A
N/A
40%
N/A
100%
N/A
20x EBITDA
N/A
7.5x Fw. EBITDA
N/A
8.5x Fw. EBITDA
8.3x Fw. EBITDA
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
Feb-13
May-12
Jan-13
Jan-13
Feb-12
Nov-11
Aug-11
Jul-11
Mar-11
Oct-10
Jul-10
Jun-10
Sep-09
May-05
Source: Companies, local newswires and Brasil Plural Research
June 13, 2013
While we wait for the global players to make bigger moves, the consolidation of the
smaller chains should continue. At this point, we don’t question whether the
international players will have an important role in the final consolidation of the
Brazilian market: they will. However, the timing is still uncertain. In the meantime, we
expect local players to continue their expansion within Brazil, through a mix of organic
growth and smaller acquisitions. Some of the largest players such as Raia Drogasil,
DPSP and Brasil Pharma are now involved in their own integration processes in the
wake of transformational deals that happened in the last two years, and in delivering
on their organic growth plans. As a result, we believe they would only make
opportunistic acquisitions until they complete their integration. Others, like Pague
Menos, prefer to keep on growing organically by gaining market share from the
independent mom and pop shops which lost part of their competitive advantage due
to measures taken by the government to fight tax evasion and enhance the reliability
of pharmaceutical products by the phasing out of similar products. Among the
measures to fight tax evasion were the tax substitution system (in 2008, the Brazilian
IRS started to charge VAT tax at the supplier level instead of retail) and the electronic
invoicing system. This scenario bodes well for Profarma, and we believe the company
will enjoy a sweet spot to carry on its new strategy to increase its retail operations
through consolidation.
100%
Avg.
Monthly
Sales
(R$'000)
88%
75%
40%
38%
40%
20%
25%
20%
60%
62%
60%
100%
80%
50%
80%
Small chains and independent
players should keep on the
consolidation wave until global
players make their moves or intrachain M&A start to appear.
13%
Cummulative Mkt. Share (R$)
100%
0%
0%
Cat. 1
Cat. 2
Cat. 3
Cat. 4
Cat. 5
Cat. 6
Cat. 7
Cat. 8
R$1,267
R$592
R$377
R$237
R$134
R$70
R$35
R$10
Mkt. Share (R$)
Cummulative Mkt. Share (#Stores)
Chart 17: Plenty of Room Left for Potential Consolidation of Smaller Players
Mkt. Share (#Stores)
Source: Brasil Pharma/IMS and Brasil Plural Research
Can Profarma Be the Next Consolidator?
Profarma will enjoy a sweet spot to achieve some critical mass in the retail segment
as the large players focus on integrating their operations. In our view, there’s still
room for Profarma to consolidate smaller players outside the state of Rio de Janeiro,
and the acquisitions of Tamoio and Drogasmil/Farmalife serve as good indicators that
the company is up for it. As the large players focus on integrating their operations, we
believe that Profarma is in a good position to carry on this consolidation -- as it is
present in all regions in Brazil and it has a direct relationship with about 50% of the
drugstores in the country, which we believe grants the company a head start to
identify potential acquisition opportunities. In the table below we list a few of the
remaining assets that we view as potential targets.
June 13, 2013
Chart 18: Profarma’s Sweet Spot – Potential Acquisition Targets and Current Footprint
Target
Region
Stores
Droga ri a Ara ujo
MG
110
Droga l
SP
90
Fa rma Ponte
SP
76
Drogã o Super
SP
61
Indi a na
MG
60
Droga Verde
SP
52
Extra fa rma
NE
39
Fa rma ci a Sa nta Luci a
PR
32
Droga ri a s Angel i ca
AM
24
Droga Li der
MG
24
Droga ri a Mi na s Bra s i l
MG
24
Droga Fa rma
SP
23
Droga ri a Vena nci o
RJ/SP
22
A Nos s a Droga ri a
RJ
20
Distribution Center/Service
Service
Distribution
Center/Service
+ Retail Outlets
Source: ESPICOM, Profarma and Brasil Plural Research
The main question is whether Profarma will be able to find good assets at accretive
prices, as it trades at low multiples. In our view, the recent track record is positive,
but may not be the benchmark for deals to come. In the case of Tamoio, Profarma
paid 7.5x EV/EBTIDA for 50% of the business with a call option to buy the remaining
50% at the same multiple, which is line with Profarma’s own trading multiple (see
chart 20). For Drogasmil, the valuation paid was not based on EV/EBITDA, as its
operations were under distress with nearly zero EBITDA. However, if we consider the
R$1.0 million price per store, we view it as accretive as Drogasmil had very good
locations in the city of Rio de Janeiro, where retail rent space is scarce and expensive
(see Chart 19). On the other hand, valuation could be an issue for the next deals after
CVS paid an estimated 20x EV/EBITDA for Onofre as we believe that Profarma may
have to up the ante to complete the next acquisitions.
Chart 19: Drogasmil Snapshot
Chart 20: Tamoio Snapshot
Brands
Brands
Region
Stores
Gross Sales (2011A)
9M12 YoY Gross Sale Growth
Gross Sales YoY Growth YE13E
EBITDA Margin 9M12
EBITDA Margin 2013E
Past EBITDA Mg.
EV (R$mn)
EV/Sales
EV/Stores (R$mn)
RJ
85
R$333mn
-10.0%
15%
~0%
3.2%
6.5%-5.5%
87
0.3x
1.0
Region
Stores 2012
Stores (CAGR '10-12)
Gross Sales 2012
Sales (CAGR '10-12)
SSS (2012)
SSS (2011)
EBITDA Margin
EV (R$mn)
EV/Sales
EV/EBITDA
EV/Stores (R$mn)
RJ
57
16%
R$312.3mn
19.8%
8%
11%
5%
117
0.4x
7.5
2.3
June 13, 2013
Profarma will have to be capitalized if it is serious about its strategy to take
advantage of this opportunity to consolidate the market. According to our estimates,
Profarma’s net debt to EBITDA should peak at nearly 4.0x by YE2013 (chart 21),
following the acquisitions of Drogasmil and Tamoio, assuming that the company will
exercise its call option to acquire the remaining 50% of Tamoio. The company has
recently raised R$200 million in local bonds to fund these acquisitions. Even though
Profarma is still running below the agreed 5.5x net debt to EBITDA covenant in the
recently issued bond, we believe that its capital structure will be a limitation for
additional acquisitions. We thus believe that it will be crucial for Profarma to do a
follow on offering to improve its capital structure to take advantage of the
consolidation window. If that is the case, we believe that there could be a positive
effect on the stock liquidity (chart 22).
25%
18
16
14
12
10
8
6
4
2
0
20%
15%
10%
5%
Source: Company data and Brasil Plural Research;
*Disregarding any share offering
Free Float
Nov-12
May-13
Nov-11
May-12
Nov-10
May-11
Nov-09
54%
3.8x
May-10
63%
2.6x
Nov-08
Debt/Equity [a/b]
Net Debt/EBITDA [a/c]
May-09
0%
Value Traded (R$million)
Chart 22: A Follow-On Could Boost ADTV
Free Float (%)
Chart 21: Profarma’s Capital Structure
LTM
2013E*
Net Debt [a]
240
432
Gross Debt
359
540
Cash
119
109
Equity [b]
569
993
EBITDA [c]
91
112
ADTV (R$million)
Source: Company data and Brasil Plural Research;
ADTV = average daily traded volume
Global Trends: Moving Towards an Integrated Model
The US Segregated Model vs. the European Integrated Model: which will prevail in
Brazil? The European and the US drug retail markets maintain some distinct
characteristics, which we believe will influence the appetite of the international
players when they look into expanding into new markets in general and more
specifically into Brazil. In the case of Europe, we view regulation as an important
barrier for the expansion of drug retail conglomerates, as many countries still prevent
the creation of drugstore chains. However, the integration of retail and distribution is
already in place, with Alliance Boots in the UK and Celesio in Germany as the primary
examples. In the US, on the other hand, the consolidation of the drug retail business
started in the 90’s, independently from the distribution business, and drugstores
became a convenience store, carrying a wide array of products -- including food,
beverages, small appliances and household cleaning products. The consolidation of the
US drug retail market happened in tandem with the migration from the “buy and hold”
model to “fee for service”, as stronger retailers demanded less working capital
financing and higher discounts from distributors and the pharmaceutical industry.
June 13, 2013
Chart 23: Contrasting Dynamics in the US and European Pharma Industries
USA
EUROPE
Integrated Model is a Possible a Reality
RETAIL AND
DISTRIBUTION
RELATIONSHIP
Integrated Model is Common
Dru gsto re
Drugstore
Dru gsto re
Drugstore
Dru gsto re
Dru gsto re
Distribution
Retail
Distribution
Retail
Dru gsto re
Dru gsto re
Flexible
 Appropriate licenses to open
drugstores are required , but quite
accessible to entrepreneurs
REGULATION
Stringent, Varying by Country
 Opening of new pharmacies is
highly regulated
 Vertical integration is a key
trend, though closely watched
Unconstrained, Drugstores are Convenience Outlets
 Pharmacies are free to
sell a wide assortment
from drugs to foodstuff
ASSORTMENT
IN PHARMACIES
Limited, Varying by Country
 As most drugstores are
owned by pharmacists, CF&T
and beauty products are still
only starting to build up
Chart 24: Distribution Models Concepts
Buy-and-Hold
DISTRIBUTION
MODEL
Fee-for-Service
Distributors fund working capital needs
Distributors operate as a logistics
of retailers. Drug wholesalers are allowed solutions provider, and do not engage in
to purchase from manufacturers more
inventory/WC management for the
products than required to meet customer
industry or the retailer. Wholesalers
needs. With this, wholesalers engage in
agrees to reduce or eliminate forward
forward buying to maximize profits,
buying of a manufacturer's products in
where they intentionally and actively
return for a fee structure or payment
strive to maintain higher inventory levels from the manufacturer. This offsets part
at current prices to take advantage when of the wholesaler's profitability loss from
price adjustments take place.
the discontinuation of forward buying.
We now have one player from each of those markets in Brazil, still with a relatively
small market share – Celesio on the distribution side and CVS in retail. We believe it
is still early to picture which model will prevail in Brazil, but some recent events may
help shed some light on the direction that the market is going, pointing at the
integrated model. First, the association of drug retailer Walgreens and drug distributor
AmerisourceBergen in the US may indicate some changes toward the European model
of integration. Secondly, Profarma’s move into retail may also point to an integrated
model in Brazil, which may be ignited further if Celesio decides to replicate its
European model and enter in retail in Brazil.
# Stores
Cash Conversion Cycle
10
1,000
# Stores
Jan-12
Jan-11
Jan-10
0
Jan-09
0
Cash Conversion Cycle (days)
20
2,000
Jan-08
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
0
30
3,000
Jan-07
10
40
4,000
Jan-06
20
50
5,000
Jan-05
30
60
6,000
Jan-04
40
70
7,000
Jan-03
50
8,000
Jan-02
60
# Stores
70
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
Jan-03
# Stores
Chart 25: US Drugstores Demanded Lower Cash Cycle Funding as They Consolidated
Cash Conversion Cycle
Source: Companies data and Brasil Plural Research
We believe that the development of a hybrid model was a good move and may bring
additional gains in working capital. Unlike the US market, Brazil still operates
predominately under the “buy and hold” model as the market is fragmented and the
small mom and pop drugstores depend on the distribution companies to fund their
working capital needs. The recent concentration started to change this as large
drugstore chains have more firepower to fund their own working capital needs and
June 13, 2013
prefer to squeeze distributor margins or go direct to the pharmaceutical industry to
improve margins rather than financing their working capital needs. In any case,
margins for both retailers and distributors are still thin, and working capital needs are
relatively high. As a result, cash cycle management is crucial to assure sufficient
returns in the business. In our view, the hybrid model can help to bring the working
capital in the retail business to a more optimal level. This is the case for Celesio, which
boasts a lower cash conversion cycle when compared to Walgreens and CVS (chart 26).
As a result, we believe that Profarma can present better cash cycle in the retail
business than peers Raia Drogasil and Brasil Pharma, due to the synergies with its
distribution business (chart 27).
Chart 27: Potential Gains for Profarma
80
CVS
Walgreens
Celesio
20
Raia Drogasil
Profarma
Jan-12
10
Jan-11
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
10
Profarma:
distribution
only
30
Jan-10
20
40
Jan-09
30
50
Jan-08
40
60
Jan-07
50
70
Jan-06
60
Jan-05
70
Jan-02
Chart 26: Integrated Is More Efficient
Brasil Pharma
June 13, 2013
Valuation
Earnings Outlook and Intrinsic Valuation
We derive our base case price targets for drug retailers using a DCF methodology.
The inputs and assumptions informing our DCFs are all provided explicitly in each
company’s valuation section, so we won’t detail in text what the reader can more
easily review in the exhibits. Nonetheless, it is important to note that our assumptions
take into account the key value drivers that we discuss in the Investment Summary
section of this report. From our perspective, key value drivers for the drug retail
industry translates into four main metrics in our models: store openings, gross
margins, SG&A dilution, and working capital.
Chart 28: Store Openings, Gross Margins, SG&A Dilution and Cash Cycle
Management Are the Main Drivers
Footprint
Store Openings
Scale
Gross Margins
Competitive Pressure
Sales Mix
Operating Performance
SG&A Dilution
Cash Cycle
Management
Quality of Management
From a top-down perspective, we believe that drug retailers will keep on benefitting
from the strong secular growth drivers in Brazil, namely: 1) the aging of the population;
2) the increase in the number of emerging consumers; 3) an increase in the disposable
income of the population as a whole; and 4) the increase in the sale of generics. Aside
from that, we believe that consolidation will continue to play an important role and
drive store openings, as large retailers gain share over smaller chains and mom and
pop stores. We do not bake into our numbers the underlying value in the case of an
M&A, which we believe could happen for any of the companies in our coverage.
However, we assess the potential control premium in our bull scenario analyses (see
charts 36, 39, and 42, pages 23, 25 and 27). Below we describe our views on the most
important metrics in our models:
Store openings: our general view for the industry is that listed drug retailers will
gain share from informal players. The main store opening driver for Raia Drogasil
and Brasil Pharma will be organic growth, as they are focusing on the their
integration processes. In our view, Raia Drogasil and Brasil Pharma are on track to
deliver on the guided organic growth of 130 and 100 store openings per year,
respectively, starting as of 2014. As they focus on organic growth, Profarma will
have the opportunity to complete new acquisitions and reach the intended number
of 500 stores by YE15. In order to achieve this goal, we assume two large
acquisitions of 155 stores each, plus the organic growth of 20 stores per year,
which was the store opening run rate of Tamoio.
June 13, 2013
350
300
300
250
200
125
150
100
130
130
100
88
70
50
50
350
326
300
250
200
150
100
100
70
100
52
42
50
0
40
0
2012A 2013E 2014E 2015E 2016E 2017E 2018E
Store Openings
Stores Acquired
Number of Stores
350
Number of Stores
Number of Stores
Chart 29: PFRM to be the Next Consolidator; RADL and BPHA to Grow Organically
250
175
200
175
147
150
100
50
0
20
20
20
0
2012A 2013E 2014E 2015E 2016E 2017E 2018E
Store Openings
Stores Acquired
2012A 2013E 2014E 2015E 2016E 2017E 2018E
Store Openings
Stores Acquired
Gross margins: we take a conservative stance and do not forecast significant
gains in gross margins. We expect annual price increases to continue to represent
a potential margin booster in the second quarter of every year. On the other hand,
we expect a positive impact from scale gains and an increasing share of generics in
the sales mix to be offset by more intense price competition. Over the past three
years, drug retailers and distributors gained on average 150bps in their gross
margins, which we find low given the big scale gains that they achieved. In our
view, the scale gain was offset by the increasing competitive pressure in the
Southeast and in other regions. As a result, we expect Raia Drogasil and Brasil
Pharma’s margins to remain flat at around 27% and 30% of gross revenues,
respectively. However, we view a higher downside risk to Brasil Pharma’s margins,
as they are currently in regions with relatively lower competitive pressure but
competition has been stepping up. For Profarma, we expect margins to increase to
12.4% of gross revenues by 2015, up from 5.4% in 2012, as the share of retail
increases to 32% of sales.
Gross Margin - % of Gross Sales
Chart 30: We Expect Gross Margins to Remain Flat; PFRM3 to Benefit from Retail
35.0%
30.0%
25.0%
40% Distribution (9.7% margin)
60% Retail (26.9% margin)
20.0%
15.0%
100% Distribution
0% Retail
10.0%
5.0%
0.0%
2012A
2013E
Profarma
2014E
2015E
2016E
Brasil Pharma
2017E
2018E
Raia Drogasil
SG&A dilution: these are the lines that embed the greatest potential for synergies
stemming from recent organic growth consolidation moves. However, the
capacity to capture these potential synergies is directly related to the quality of
management and can be overshadowed by stepped up competition. Over the
past three years, selling expenses have scaled up 320bps to 17.6% of gross sales,
pressured by increases in rent and labor costs, and by the increase in the share of
the non-mature store base and pre-operating expenses related to the opening of
new stores. In our view, selling expenses should stabilize scale back to 17.4% of
gross sales until 2017, but still higher than 15.8% in 2010 as store costs have
increased ahead of inflation. For G&A, we expect more dilution opportunity as
integration moves along, particularly for Brasil Pharma, which comes from a much
higher base on the back of its hefty regional structure. In any case, we expect
overall SG&A expenses to become less volatile as non-recurring expenses related to
the merger moves wane. For Profarma, we expect the recent ramp up in G&A to
June 13, 2013
continue to pressure EBITDA margin in the distribution business. However, we
expect the consolidated EBITDA margin to increase to 4.3% in 2017, up from 2.4%
in 2012, as it rolls out its retail strategy and the business reaches 58% of EBITDA.
22.0%
G&A Expenses- % of Gross Sales
Selling Expenses- % of Gross Sales
Chart 31: We Remain Cautious About Pricing in Potential Synergies at the SG&A Level
17.0%
12.0%
7.0%
2.0%
-3.0%
2012A
2013E
2014E
2015E
2016E
2017E
2018E
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
2012A
Profarma
Brasil Pharma
Raia Drogasil
2013E
Profarma
2014E
2015E
2016E
Brasil Pharma
2017E
2018E
Raia Drogasil
Cash cycle management: the drug retail and distribution low margins make cash
cycle crucial to determining shareholder returns. In our view, the opportunity lies
in potential synergies from retail and distribution integrated model. The average
cash cycle for drug retailers has been 55 days over the past three years. During this
period, Raia Drogasil has seen the cash cycle worsen by 35 days after Raia raised
funds through its IPO and reduced the number of days of suppliers in exchange for
better procurement discounts. Brasil Pharma, on the other hand, presents 65 days
as it is still performing the integration of the acquired assets. In the case of
Profarma, the company has managed to reduce its cash cycle by about one or two
days every year. However, we believe that there is potential to further reduce its
cash cycle as it integrates its retail and distribution operations (chart 32).
Chart 32: Profarma Should Benefit From Potential Gains Stemming From Distribution + Retail model
2,000
40
0
20
-1,000
-2,000
0
2009 2010 2011E 2012E 2013E 2014E 2015E
Total WC
Inventories
Receivables
Payables
Cash Cycle (days)
60
1,000
40
0
20
-1,000
3,000
-2,000
0
2012A 2013E 2014E 2015E 2016E 2017E 2018E
Total WC
Inventories
Receivables
Payables
Cash Cycle (days)
80
2,000
60
1,000
40
0
20
-1,000
-2,000
0
2012A 2013E 2014E 2015E 2016E 2017E 2018E
Total WC
Inventories
Receivables
Payables
Cash Cycle (days)
Intrinsic Value Debate: Assessing the Value of Synergies
Potential synergies from past M&A moves continue to drive the underlying value of
drug retail assets in the form of gross margin accretion and SG&A dilution. The longcoveted synergy benefits that should arise from larger chains are still not currently
present in reported figures, mainly as a result of several integration hurdles. However,
we believe synergies from larger platforms may surface once integration is behinds us.
From our perspective, the main synergies should materialize as improvements in: (a)
gross margin, through procurement gains, enhanced trade marketing, and richer sales
mix; and (b) SG&A dilution, driven by footprint optimization and fixed-cost dilution.
We incorporate partial synergies into our Raia Drogasil and Brasil Pharma models,
but the market does not seem to be pricing much into the latter. Our sensitivity
analysis shows that Raia Drogasil’s potential gross-margin expansion may be currently
being overlooked by us and the market, albeit the inclusion of some SG&A gains (chart
33). On the other hand, the market is pricing zero gross margin synergies in Brasil
Pharma, coupled with only limited gains in SG&A, which we see as conservative (chart
Cash Cycle (days)
60
1,000
80
R$mn
3,000
Cash Cycle (days)
80
R$mn
R$mn
2,000
Cash Cycle (days)
3,000
June 13, 2013
34). For those more bullish with synergy gains, our sensitivity tables also show that in a
blue-sky scenario, where most synergies are captured, Raia Drogasil and Brasil Pharma
could trade 40% and 30% above our DCF fair-values, respectively.
Chart 33: Raia Drogasil – Synergies Sensitivity Table
Chart 34: Brasil Pharma - Synergies Sensitivity Table
June 13, 2013
Profarma
Our DCF valuation for Profarma yields a YE14 target price of R$24 per share. Our
model for Profarma yields a 3-yr Fwd revenue CAGR of 18.0%, driven by the acquisition
of 310 drugstores and the opening of 20 greenfield stores per year to achieve
management’s plan to have 500 stores by the end of 2015. We assume that Profarma
raises R$400 million to fund the new acquisitions through a follow on offering, priced
at the current market value of R$16.50 per share, resulting in the issuance of 22.2
million shares and a dilution of 40% to current shareholders. We estimate that
Profarma’s gross margin climbs to 14% by 2015, boosted by the increase in the share
of retail, which will represent 32% of sales. EBITDA margin reaches 3.8% in the same
period, with retail contributing with 50% of consolidated EBITDA with an EBITDA
margin of 6.0% in retail operations. As a result, we expect a 3-yr EPS CAGR of 54%.
Chart 35: Profarma Free Cash Flow Estimates and DCF Valuation (R$ million)
FY14E
99.6
(23.9)
75.7
83.1
158.7
(252.6)
(148.4)
(5.6)
FY15E
138.6
(33.3)
105.3
124.4
229.7
(284.8)
(127.3)
(6.9)
FY16E
197.5
(47.4)
150.1
132.4
282.4
(94.3)
(27.2)
(7.7)
FY17E
232.2
(55.7)
176.5
124.3
300.8
(98.0)
(63.1)
(8.2)
FY18E
266.5
(64.0)
202.5
119.3
321.9
(105.6)
(65.9)
(8.8)
FY19E
305.3
(73.3)
232.0
116.7
348.8
(109.5)
(69.6)
(9.5)
FY20E
338.6
(81.3)
257.3
116.1
373.4
(117.9)
(74.3)
(10.1)
FY21E
372.1
(89.3)
282.8
117.4
400.3
(126.8)
(79.5)
(10.8)
FY22E
406.5
(97.6)
309.0
120.6
429.5
(136.3)
(80.9)
(11.6)
FCF
YoY
(247.9)
NM
0
-
(189.3)
NM
0
(167.5)
153.2
NM
0
120.0
131.5
-14.2%
0
91.2
141.5
7.6%
0
86.8
160.2
13.2%
0
87.0
171.1
6.8%
0
82.3
183.0
7.0%
0
77.9
200.6
9.6%
0
75.6
Present value FCF
Discount rate calculation
US risk-free rate (10-yr. bond yield)
Country risk premium
Beta
Equity risk premium
Devaluation risk
Cost of equity
After-tax cost of debt
Equity as percent of LT financing
WACC
Perpetuity growth
3.00%
2.00%
1.00
6.5%
3.0%
14.5%
8.4%
75%
13.0%
6.0%
PV of cash flow (R$ millions)
(-) Net Debt (end 2014)
1,627
327
Equity value (end 2014)
Number of shares
1,300
55.5
Liquidity discount
0%
TARGET PRICE (in 2014)
Current price
Upside
Perpetuity growth
FCF (R$ millions)
EBIT
(-) Taxes
NOPLAT
(+) Depreciation and amortization
GROSS CASH FLOW
(-) Capex
(+) Change in WK
(-) Minorities
24.00
5.0%
5.5%
6.0%
6.5%
7.0%
12.0%
26.0
28.0
30.0
32.0
35.0
12.5%
23.0
25.0
27.0
29.0
31.0
WACC
13.0%
21.0
23.0
24.0
26.0
27.0
FY23E Perpetuity
443.3
(106.4)
336.9
125.2
462.0
(146.6)
(85.6)
(12.4)
217.5
8.4%
0
72.5
13.5%
19.0
20.0
22.0
23.0
25.0
3,303.6
0
1,101.6
14.0%
18.0
19.0
20.0
21.0
22.0
24.00
16.50
45%
According to our estimates, the current stock price of R$16.50 is below our bear-case
scenario, which excludes new acquisitions in the retail business, dragging down the
share of retail to 16% of consolidated sales and 28% of EBITDA by 2015. In our view,
the market is still reticent on pricing in the benefits from the integrated model and is
also demanding a 25% liquidity discount. Similar to Raia Drogasil and Brasil Pharma, we
derive our bull case from Profarma’s potential value in a takeover event. However,
unlike Raia Drogasil and Brasil Pharma, we analyze the potential value through a sumof-the-parts methodology. We presume that the retail part will represent 50% of
EBITDA by 2015 and will be valued at Raia Drogasil’s 2015E EV/EBITDA multiple of 12x.
Then we assume that the distribution business will be valued at Profarma’s current
multiple of 7x EV/EBITDA. The sum of the parts results in a fair value of R$35 per share.
Chart 36: PFRM3: Market Is Not Pricing the Retail Opportunity
YE14 Target Price (R$/share)
40.0
R$35.0
35.0
30.0
25.0
Our bear case excludes new
acquisitions in the retail
business
R$24.0
20.0
Our bull case considers a
takeover valuing retail
business at 12x EBITDA and
distribution at 7x EBITDA
15.0
10.0
5.0
R$19.0
-
Base Case
Bull Case
Bear Case
June 13, 2013
Chart 37: Profarma Fact Sheet
BALANCE SHEET (R$ million)
Total Assets
Current assets
Cash and equivalents
Receivables
Inventories
Other
Long-term assets
Permanent assets
2010
1,071
1,002
12
403
378
209
32
37
2011
1,227
1,141
23
474
409
234
31
56
2012E
1,431
1,300
49
551
426
274
50
81
2013E
2,249
1,930
509
609
480
333
52
267
2014E
2,396
1,907
162
768
593
384
52
437
2015E
2,731
2,082
43
880
714
445
52
597
Liabilities + Shareholders' Equity
Current liabilities
Loans
Payables
Other
Non-current liabilities
Loans
Other
1,071
432
44
367
21
119
76
43
519
1,227
510
44
435
31
163
98
65
555
1,431
691
139
515
38
169
84
85
571
2,249
789
152
586
50
468
389
79
993
2,396
941
129
751
61
439
360
79
1,016
2,731
1,097
113
905
79
577
498
79
1,058
INCOME STATEMENT (R$million)
Net Revenues
Cost of Goods Sold
Gross Profit
SG&A
Other Operating Revenues (Expenses)
EBIT
Financial Results
EBT
Income Taxes and Social Contributions
Net Income
Adjusted EBITDA
SIMPLIFIED CASH FLOW (R$million)
EBIT
(+) Depreciation
(+/-) Δ Working capital
(-) Taxes paid
(+/-) Financial results
Other
Operating cash flow
Investing cash flow
Financing cash flow
2010
2011 2012E 2013E 2014E 2015E
2,626
2,810 3,233
3,816
4,932
6,081
(2,445) (2,646) (3,028) (3,491) (4,355) (5,227)
181
164
205
324
577
854
(207)
(211)
(264)
(387)
(630)
(877)
90
113
144
143
152
161
63
66
84
80
100
139
(34)
(31)
(29)
(47)
(62)
(68)
29
35
56
34
38
70
(6)
(5)
(13)
(6)
(9)
(17)
29
29
40
25
23
47
69
73
92
112
183
263
2010
63
5
-19
-6
-34
-31
-21
-8
-10
2011
66
6
-31
-5
-31
-16
-10
-31
48
2012E
84
8
-29
-13
-29
-48
-26
-11
49
2013E
80
32
-75
-6
-47
-52
-67
-219
711
2014E
100
83
-148
-9
-62
-41
-78
-253
-57
2015E
139
124
-127
-17
-68
-42
8
-285
110
OPERATING DATA
Total Number of Stores
Total Sales Area ('000 sq. m²)
SSS Growth - Retail
Net Revenues from Distribution (R$mn)
Net Revenues from Retail (R$mn)
Gross margin from distribution
Gross margin from retail
2010
NM
2,626
10.7%
NM
2011
NM
2,810
10.2%
NM
2012E
NM
3,233
11.0%
NM
2013E
147
NM
3,472
343
11.2%
25.5%
2014E
322
27.6
NM
3,744
1,188
11.3%
26.7%
2015E
497
45.1
9.1%
4,003
2,078
11.3%
27.7%
CAPITAL STRUCTURE
Total Debt
Net Debt
% Short Term
Net Debt / EBITDA
EBIT/Interest
Debt/Equity
2010
120
109
37%
1.6x
1.8x
23.2%
2011
143
120
31%
1.6x
2.1x
25.7%
2012E
223
173
62%
1.9x
2.9x
39.0%
2013E
540
32
28%
0.3x
1.7x
54.4%
2014E
489
327
26%
1.8x
1.6x
48.1%
2015E
610
567
18%
2.2x
2.0x
57.7%
# Shares (million)
EPS
BVPS
Dividends (R$mn)
DPS
Pay Out %
Div. Yield %
2010
33
0.87
15.65
9
0.26
30%
1.7%
2011
33
0.87
16.65
3
0.08
9%
0.7%
2012E
33
1.21
17.15
0
0.00
0%
0.0%
2014E
56
0.41
18.30
6
0.10
25%
0.6%
2015E
56
0.84
19.05
12
0.21
25%
1.3%
RETURN
FCF Yield
ROE
ROA
ROIC
2010
5.3%
5.5%
2.7%
12.3%
2011
-1.7%
5.4%
2.5%
11.8%
2012E 2013E 2014E
6.4% -22.3% -27.1%
7.2%
3.2%
2.3%
3.0%
1.3%
1.0%
15.0% 10.7% 10.6%
2015E
-20.7%
4.5%
1.8%
11.8%
2010
1.9%
13.3%
6.9%
-37.8%
17.7%
2.6%
-39.7%
2.4%
-46.0%
-4.9%
1.1%
2011
7.0%
20.6%
5.8%
5.5%
35.9%
2.6%
4.4%
2.4%
0.4%
-7.3%
1.0%
2012E 2013E
15.1% 18.0%
23.4% 21.4%
6.3%
8.5%
26.9% 21.7%
41.8% 43.2%
2.9%
2.9%
27.4%
-5.0%
2.6%
2.1%
39.4% -38.6%
5.0% 53.9%
1.2%
0.6%
2014E 2015E
29.3% 23.3%
14.0%
8.9%
11.7% 14.0%
62.7% 44.0%
25.0% 13.6%
3.7%
4.3%
24.1% 39.2%
2.0%
2.3%
-7.0% 103.0%
69.5% 42.8%
0.5%
0.8%
VALUATION
Share Price (R$/s)
Market Cap (R$m)
EV (R$m)
EV/Sales
EV/EBITDA
P/Sales
P/E
PEG
P/BV
2010
14.99
497
606
0.2x
8.8x
0.2x
17.3x
(3.5)
1.0x
2011
10.49
349
469
0.2x
6.5x
0.1x
12.1x
(1.7)
0.6x
2012E
14.37
478
652
0.2x
7.1x
0.1x
11.9x
2.4
0.8x
2013E
16.50
916
948
0.2x
8.4x
0.2x
37.1x
0.7
0.9x
2014E
16.50
916
1,243
0.3x
6.8x
0.2x
39.8x
0.6
0.9x
2015E
16.50
916
1,483
0.2x
5.6x
0.2x
19.6x
0.5
0.9x
VALUATION at TARGET
P/Sales
EV/EBITDA
P/E
PEG
2010
2011
2012E
2013E
0.3x
12.2x
53.9x
1.0
2014E
0.3x
9.1x
58.0x
0.8
2015E
0.2x
7.2x
28.6x
0.7
MARGINS and RATIOS
Net Revenue YoY Growth
Revenue Fwd 3-yr CAGR
Gross Margin
EBITDA YoY Growth
EBITDA Fwd 3-yr CAGR
Adjusted EBITDA Margin
EBIT Growth
EBIT Margin
Earnings YoY Growth
Earnings Fwd 3-yr CAGR
Net Margin
Profarma (PFRM3; Overweight)
2014YE Price Target (R$)
Last Price (R$)
Upside/Downside (%)
Curr. Market Cap(R$mn)
Avg. daily value(R$mn)
52-week price range
2013E
56
0.45
17.89
6
0.11
25%
0.7%
24.0
16.50
45.5%
549
3.5
R$25.10 - R$9.50
June 13, 2013
Raia Drogasil
Our DCF valuation for Raia Drogasil yields a YE14 target price of R$25 per share. Our
model for Raia Drogasil results in a revenue CAGR of 18.7% for the next three years,
driven by the company’s guidance of opening 130 stores per year and an average SSS
growth of 9.2% in the period. We also estimate that gross margin as a percentage of
gross revenues will remain flat at approximately 27.2%. We expect synergies from the
integration of Raia and Drogasil to kick in, boosting EBITDA margin to 7.3% by 2015, up
150bps from 2012, yielding a 23% EPS CAGR in the same period.
Chart 38: Raia Drogasil Free Cash Flow Estimates and DCF Valuation (R$ million)
FY14E
FY15E
FY16E
FY17E
FY18E
FY19E
EBIT
364.1
455.9
568.0
680.5
784.7
912.7
1,023.7
1,136.0
1,237.0
1,354.9
(69.0)
160.1
455.3
(250.2)
(148.4)
-
(95.7)
184.1
544.4
(271.6)
(145.4)
-
(129.1)
202.6
641.5
(253.2)
(139.5)
-
(163.0)
210.6
728.1
(254.2)
(144.0)
-
(194.2)
223.1
813.6
(295.4)
(159.2)
-
(232.5)
238.5
918.7
(249.8)
(156.5)
-
(307.1)
245.6
962.2
(274.5)
(150.0)
-
(340.8)
251.8
1,047.1
(270.6)
(152.9)
-
(371.1)
261.0
1,126.9
(296.1)
(155.8)
-
(406.5)
268.5
1,217.0
(290.0)
(162.4)
-
56.7
-32.3%
0
51.1
127.4
124.8%
0
103.8
248.8
95.4%
0
183.0
330.0
32.6%
0
219.1
359.0
8.8%
0
215.2
512.4
42.7%
0
277.2
537.7
4.9%
0
262.6
623.5
16.0%
0
274.9
675.0
8.2%
0
268.6
764.6
13.3%
0
274.7
(-) Taxes
GROSS CASH FLOW
(-) Capex
(+) Change in WK
(-) Minorities
FCF
YoY
0
Present value FCF
Beta
Equity risk premium
Devaluation risk
Cost of equity
WACC
Perpetuity growth
3.00%
2.00%
0.70
6.5%
3.0%
12.6%
6.6%
70%
10.8%
6.0%
(-) Net Debt (end 2014)
8,224
83
Number of shares
8,141
330.4
TARGET PRICE YE14 (R$/share)
Current price
Upside
25.00
21.42
17%
Perpetuity growth
FCF (R$ millions)
25.00
5.0%
5.5%
6.0%
6.5%
7.0%
FY20E
9.8%
27.0
29.0
32.0
36.0
42.0
FY21E
10.3%
24.0
26.0
28.0
31.0
35.0
FY22E
WACC
10.8%
21.0
23.0
25.0
27.0
30.0
FY23E Perpetuity
11.3%
19.0
21.0
22.0
24.0
26.0
16,959.9
0
6,093.4
11.8%
18.0
19.0
20.0
21.0
23.0
Current stock price of R$21.4 per share is slightly below our base-case scenario. We
derive our bull-case value from a potential consolidation value in a takeover event, and
we assume that Raia Drogasil gets sold at a similar multiple paid by CVS in the
acquisition of Onofre, estimated at 20x EBITDA. Considering Raia Drogasil’s 2014E
EBITDA and net debt, the fair value per stock would be R$35. Our bear case assumes
that Raia Drogasil does not capture any synergies in selling expenses, as inflation
continues to pressure store rent and personnel costs and offset the dilutive effect of
the maturing stores, and selling expenses remain flat at 18% as a percentage of sales.
In this case, the fair value per share would be R$19.
Chart 39: RADL3: Current Stock Price Reflects Intrinsic Value
40.0
R$35.0
35.0
30.0
R$25.0
25.0
Our bull case
considers a
takeover valuing
Raia Drogasil at
20x EBITDA YE14
20.0
15.0
10.0
5.0
Our bear case excludes
synergy gains in selling
expenses, keeping it at
18% of sales
R$19.0
-
Base Case
Bull Case
Bear Case
June 13, 2013
Chart 40: Raia Drogasil Fact Sheet
Total Assets
Current assets
Receivables
Inventories
Other
Long-term assets
Permanent assets
2010
2,016
1,516
577
219
603
117
87
413
2011
3,168
1,626
340
288
815
183
44
1,498
2012E
3,340
1,694
167
336
973
218
22
1,625
2013E
3,657
1,925
183
392
1,084
266
22
1,710
2014E
4,117
2,295
274
461
1,273
286
22
1,800
2015E
4,638
2,729
408
536
1,477
308
22
1,888
Current liabilities
Loans
Payables
Other
Loans
Other
2,016
738
48
548
143
112
96
16
1,166
3,168
791
50
536
205
176
112
64
2,201
3,340
863
61
576
227
212
131
81
2,265
3,657
1,126
74
677
375
194
107
87
2,337
4,117
1,425
174
780
471
269
182
87
2,423
4,638
1,691
230
905
557
439
352
87
2,508
Net Revenues
Cost of Goods Sold
Gross Profit
SG&A
EBIT
Financial Results
EBT
Net Income
Adjusted EBITDA
EBIT
(+) Depreciation
(-) Taxes paid
Other
Operating cash flow
Investing cash flow
Financing cash flow
2010
2011 2012E 2013E 2014E 2015E
3,800
4,547
5,381
6,312
7,465
8,716
(2,853) (3,335) (3,886) (4,540) (5,334) (6,218)
947 1,213
1,494
1,772
2,131
2,498
(826) (1,033) (1,278) (1,502) (1,767) (2,042)
26
146
180
216
270
364
456
(22)
30
(3)
(9)
(12)
(25)
124
210
214
261
352
431
(33)
(59)
(60)
(41)
(67)
(90)
91
151
154
220
285
341
220
272
326
410
524
640
2010
146
74
-59
-31
-22
13
120
-218
510
2011
180
92
-270
-52
30
56
37
-1,185
911
2012E
216
110
-167
-49
-3
18
125
-300
2
2013E
270
140
-47
-33
-9
80
401
-221
-164
2014E
364
160
-137
-58
-12
47
365
-250
-23
2015E
456
184
-133
-81
-25
34
435
-272
-30
OPERATING DATA
SSS Growth - Retail
Gross margin, incl. Other operating income
2010
688
88
8.9%
3,800
25.6%
2011
776
101
10.3%
4,547
26.7%
2012E
864
114
11.5%
5,381
27.8%
2013E
977
129
8.5%
6,312
28.1%
2014E
1100
145
8.4%
7,465
28.5%
2015E
1223
163
8.5%
8,716
28.7%
CAPITAL STRUCTURE
Total Debt
Net Debt
% Short Term
Net Debt / EBITDA
EBIT/Interest
Debt/Equity
2010
143
-434
33%
-2.0x
6.7x
12.3%
2011
162
-178
31%
-0.7x
-5.9x
7.4%
2012E
192
25
32%
0.1x
84.8x
8.5%
2013E
180
-2
41%
0.0x
31.2x
7.7%
2014E
357
83
49%
0.2x
29.6x
14.7%
2015E
582
175
40%
0.3x
18.3x
23.2%
2010
320
0.28
3.65
30
0.09
33%
0.7%
2011
330
0.46
6.66
36
0.11
24%
0.8%
2012E
330
0.47
6.85
15
0.05
10%
0.2%
2013E
330
0.67
7.07
132
0.40
60%
1.9%
2014E
330
0.86
7.33
200
0.60
70%
2.8%
2015E
330
1.03
7.59
255
0.77
75%
3.6%
RETURN
FCF Yield
ROE
ROA
ROIC
2010
-1.1%
7.8%
4.5%
16.3%
2011
-5.5%
9.0%
5.8%
9.4%
2012E
-2.1%
6.9%
4.7%
7.2%
2013E
0.6%
9.6%
6.3%
9.8%
2014E
0.2%
12.0%
7.3%
12.2%
2015E
1.2%
13.8%
7.8%
13.9%
MARGINS and RATIOS
Gross Margin
EBITDA YoY Growth
EBIT Growth
EBIT Margin
Earnings YoY Growth
Net Margin
2010
16.7%
18.4%
24.9%
25.3%
23.1%
5.8%
24.3%
3.8%
20.8%
34.3%
2.4%
2011
19.7%
18.0%
26.7%
23.7%
24.5%
6.0%
23.2%
4.0%
66.7%
23.5%
3.3%
2012E
18.3%
17.4%
27.8%
20.0%
25.2%
6.1%
20.3%
4.0%
1.7%
30.3%
2.9%
2013E
17.3%
16.5%
28.1%
25.8%
23.4%
6.5%
24.8%
4.3%
42.9%
23.4%
3.5%
2014E
18.3%
14.6%
28.5%
27.9%
19.3%
7.0%
34.9%
4.9%
29.6%
19.6%
3.8%
2015E
16.8%
13.1%
28.7%
22.1%
16.3%
7.3%
25.2%
5.2%
19.4%
17.8%
3.9%
VALUATION
Share price (R$/s)
Market Cap (R$m)
EV (R$m)
EV/Sales
EV/EBITDA
P/Sales
P/E
PEG
P/BV
2010
13.24
4,231
3,797
1.0x
17.3x
1.1x
46.6x
1.4
3.6x
2011
12.89
4,257
4,080
0.9x
15.0x
0.9x
28.1x
1.2
1.9x
2012E
23.06
7,618
7,643
1.4x
23.5x
1.4x
49.5x
1.6
3.4x
2013E
21.42
7,077
7,074
1.1x
17.3x
1.1x
32.2x
1.4
3.0x
2014E
21.42
7,077
7,160
1.0x
13.7x
0.9x
24.8x
1.3
2.9x
2015E
21.42
7,077
7,252
0.8x
11.3x
0.8x
20.8x
1.2
2.8x
VALUATION at TARGET
P/Sales
EV/EBITDA
P/E
PEG
2010
2011
2012E
2013E
1.3x
20.1x
37.5x
1.6
2014E
1.1x
15.9x
29.0x
1.5
2015E
0.9x
13.2x
24.3x
1.4
# Shares (million)
EPS
BVPS
Dividends (R$mn)
DPS
Pay Out %
Div. Yield %
Raia Drogasil (RADL3; Equal Weight)
Last Price (R$)
Upside/Downside (%)
52-week price range
25.0
21.42
16.7%
7,077
22.0
R$24.59 - R$18.60
June 13, 2013
Brasil Pharma
Our DCF valuation for Brasil Pharma yields a YE14 target price of R$13.00 per share.
Our model for Brasil Pharma results in a revenue CAGR of 21.5% for the next three
years, driven by the opening of 70 stores in 2013 and 100 stores per year in 2014 and
2015, and average SSS growth of 10.7% in the same period. We also estimate that
gross margin as a percentage of gross revenues will remain flat at approximately 30%.
We expect synergies from the rollout of the shares services center (“SSC”) to kick in,
boosting EBITDA margin to 6.3% by 2015, up 150bps from 2012, yielding a 23% EPS
CAGR in the same period.
Chart 41: Brasil Pharma Free Cash Flow Estimates and DCF Valuation (R$ million)
FY14E
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
EBIT
(-) Taxes
GROSS CASH FLOW
(-) Capex
(+) Change in WK
(-) Minorities
227.0
(10.1)
61.6
278.5
(95.6)
(80.0)
-
304.0
(34.7)
68.8
338.1
(99.6)
(83.3)
-
368.2
(58.1)
72.5
382.6
(74.6)
(56.1)
-
420.3
(94.7)
69.1
394.7
(67.0)
(51.3)
-
468.8
(112.3)
67.8
424.2
(66.3)
(62.6)
-
517.1
(129.3)
67.1
454.9
(63.4)
(62.5)
-
567.1
(192.8)
66.5
440.8
(64.6)
(65.4)
-
606.5
(206.2)
65.6
465.9
(61.2)
(57.5)
-
660.7
(224.6)
64.8
500.9
(62.2)
(70.7)
-
716.6
(243.6)
64.4
537.4
(63.5)
(76.1)
-
103.0
NM
0
92.0
155.1
50.7%
0
123.9
251.8
62.3%
0
179.7
276.4
9.8%
0
176.3
295.3
6.8%
0
168.3
329.0
11.4%
0
167.5
310.8
-5.5%
0
141.4
347.1
11.7%
0
141.2
368.0
6.0%
0
133.7
397.8
8.1%
0
129.2
FCF
YoY
0
Present value FCF
Beta
Equity risk premium
Devaluation risk
Cost of equity
WACC
Perpetuity growth
(-) Net Debt (end 2013E)
3.00%
2.00%
1.00
6.5%
3.0%
14.5%
6.4%
68%
11.9%
6.0%
3,771
376.1
Fully Diluted Number of shares
3,395
266.2
TARGET PRICE YE14 (R$/share)
Current Price
Upside
13.00
10.66
22%
Perpetuity growth
FCF (R$ millions)
5.0%
5.5%
6.0%
6.5%
7.0%
10.9%
14.0
14.5
16.0
17.0
19.0
11.4%
12.5
13.5
14.0
15.0
16.5
WACC
11.9%
11.5
12.0
13.0
13.5
14.5
FY23E Perpetuity
12.4%
10.5
11.0
11.5
12.5
13.0
7,140.1
0
2,318.4
12.9%
9.5
10.0
10.5
11.0
12.0
According to our estimates, the current stock price of R$10.7 does not factor in the full
150bps in synergy gain that we are expecting in our base case as we believe that
investors are still cautious about the execution risks involved. Like Raia, we derive our
bull-case value from the potential consolidation value in a takeover event, and we
assume that Brasil Pharma gets sold at a similar multiple paid by CVS in the acquisition
of Onofre, estimated at 20x EBITDA. Considering Brasil Pharma’s 2014E EBITDA and net
debt, the fair value per stock would be R$20. Finally, our bear-case scenario
encompasses pent up competition as Raia Drogasil and DPSP advance on Brasil
Pharma’s region, causing gross margin as a percentage of gross sales to erode to 28%,
more in line with Raia Drogasil’s. In this case, the fair value per share would be R$7.50.
Chart 42: BPHA3: Small Upside in Base, but Higher Downside Risk in Our Bear Case
25.0
R$20.0
20.0
15.0
R$13.0
10.0
Our bull case considers a
takeover valuing Brasil
Pharma at 20x EBITDA YE14
5.0
Our bear case includes gross
margin eroding to 28% as a
result of fiercer competition
R$7.5
-
Base Case
Bull Case
Bear Case
June 13, 2013
Chart 43: Brasil Pharma Fact Sheet
Total Assets
Current assets
Receivables
Inventories
Other
Long-term assets
Permanent assets
2010
697
430
210
67
135
18
4
262
2011
1,058
632
264
75
227
66
16
410
2012E
2,903
1,260
369
214
552
126
88
1,555
2013E
2,930
1,220
191
260
594
176
91
1,619
2014E
3,131
1,387
178
313
703
193
91
1,653
2015E
3,384
1,609
204
371
822
212
91
1,684
Current liabilities
Loans
Payables
Other
Loans
Other
697
248
98
107
43
122
118
4
327
1,058
237
40
124
73
98
79
19
723
2,903
695
188
335
172
665
588
77
1,543
2,930
799
143
369
287
501
454
47
1,631
3,131
1,035
265
440
331
336
289
47
1,760
3,384
1,220
323
520
377
233
186
47
1,931
Net Revenues
Cost of Goods Sold
Gross Profit
SG&A
EBIT
Financial Results
EBT
Net Income
Adjusted EBITDA
2010
827
(548)
279
(237)
41
(15)
27
(6)
7
44
2011 2012E 2013E 2014E 2015E
1,065
2,876
3,430
4,203
5,013
(669) (1,928) (2,331) (2,871) (3,416)
396
948 1,099
1,332
1,596
(363)
(841)
(939) (1,105) (1,292)
(3)
(4)
1
30
103
162
227
304
(4)
(65)
(48)
(47)
(46)
26
38
114
180
258
(0)
(9)
1
(8)
(29)
23
17
113
172
228
56
166
217
289
373
EBIT
(+) Depreciation
(-) Taxes paid
Other
Operating cash flow
Investing cash flow
Financing cash flow
2010
41
3
-40
-6
-15
-192
-208
200
223
2011
30
26
-51
-0
-4
-135
-134
-30
253
2012E
103
64
-217
-9
-65
-1,008
-1,132
-207
1,494
2013E
162
55
-44
1
-48
26
152
-191
-129
2014E
227
62
-76
-8
-47
27
185
-96
-86
2015E
304
69
-79
-29
-46
27
245
-100
-102
OPERATING DATA
SSS Growth - Retail
Gross margin, incl. revenues from suppliers
2010
292
39
13.3%
827
33.7%
2011
382
49
9.8%
1,065
36.9%
2012E
708
95
14.2%
2,876
32.8%
2013E
788
111
9.9%
3,430
32.1%
2014E
888
126
8.8%
4,203
31.7%
2015E
988
141
9.7%
5,013
31.8%
CAPITAL STRUCTURE
Total Debt
Net Debt
% Short Term
Net Debt / EBITDA
EBIT/Interest
Debt/Equity
2010
216
6
45%
0.1x
2.8x
66.0%
2011
119
-145
34%
-2.6x
6.8x
16.4%
2012E
776
407
24%
2.5x
1.6x
50.3%
2013E
597
406
24%
1.9x
3.4x
36.6%
2014E
554
376
48%
1.3x
4.8x
31.5%
2015E
509
305
63%
0.8x
6.6x
26.4%
2012E
255
0.07
6.06
4
0.02
25%
0.1%
2013E
256
0.44
6.37
28
0.11
25%
1.0%
2014E
256
0.67
6.87
43
0.17
25%
1.6%
2015E
256
0.89
7.54
57
0.22
25%
2.1%
2010
2011 2012E
-0.8% -11.0% -35.1%
2.1%
4.3%
1.5%
1.0%
2.6%
0.8%
24.0%
6.7%
9.9%
2013E
-2.5%
7.1%
3.9%
8.1%
2014E
1.6%
10.1%
5.7%
11.4%
2015E
3.6%
12.4%
7.0%
15.5%
MARGINS and RATIOS
Gross Margin
EBITDA YoY Growth
EBIT Growth
EBIT Margin
Earnings YoY Growth
Net Margin
2010
2011 2012E 2013E
38.5% 28.9% 169.9% 19.3%
60.7% 58.0% 20.3% 18.4%
33.7% 37.2% 33.0% 32.0%
-21.9% 27.3% 194.8% 30.6%
69.8% 72.3% 30.9% 26.6%
5.4%
5.3%
5.8%
6.3%
-24.5% -26.2% 237.9% 57.4%
5.0%
2.9%
3.6%
4.7%
-83.6% 232.9% -27.0% 582.2%
155.0% 96.4% 139.7% 35.0%
0.8%
2.1%
0.6%
3.3%
2014E
22.5%
14.4%
31.7%
33.0%
19.2%
6.9%
40.5%
5.4%
52.2%
21.1%
4.1%
2015E
19.3%
11.1%
31.8%
29.2%
12.9%
7.4%
33.9%
6.1%
32.7%
14.4%
4.6%
VALUATION
Share Price (R$/s)
Market Cap (R$m)
EV (R$m)
EV/Sales
EV/EBITDA
P/Sales
P/E
PEG
P/BV
2010
9.00
1,005
1,011
1.2x
22.8x
1.2x
147.5x
1.0
3.1x
2011
8.49
1,356
1,212
1.1x
21.5x
1.3x
59.8x
0.6
1.9x
2012E
14.40
3,668
4,076
1.4x
24.5x
1.3x
221.4x
1.6
2.4x
2013E
10.66
2,730
3,136
0.9x
14.4x
0.8x
24.2x
0.7
1.7x
2014E
10.66
2,730
3,106
0.7x
10.8x
0.6x
15.9x
0.8
1.6x
2015E
10.66
2,730
3,035
0.6x
8.1x
0.5x
12.0x
0.8
1.4x
2010
2011
2012E
2013E
1.0x
17.2x
29.5x
0.8
2014E
0.8x
12.8x
19.4x
0.9
2015E
0.7x
9.7x
14.6x
1.0
# Shares (million)
EPS
BVPS
Dividends (R$mn)
DPS
Pay Out %
Div. Yield %
RETURN
FCF Yield
ROE
ROA
ROIC
VALUATION at TARGET
P/Sales
EV/EBITDA
P/E
PEG
Brasil Pharma (BPHA3; Equal Weight)
Last Price (R$)
Upside/Downside (%)
52-week price range
2010
112
0.06
2.93
0
0.00
0%
0.0%
2011
160
0.14
4.53
1
0.01
6%
0.1%
13.0
10.66
22.0%
2,716
11.4
R$16.65 - R$9.30
June 13, 2013
Historical Valuation Multiples
Chart 44: Profarma Historical P/E
Chart 45: Profarma Historical EV/EBITDA
50
25
40
30
20
+1 Std.
25
20
Avg.
15
10
15
+1 Std.
10
Avg.
-1 Std.
-1 Std.
0
35
30
Jan-13
Apr-13
Jul-12
Oct-12
Jan-12
Apr-12
Jul-11
Oct-11
Jan-11
Apr-11
Jul-10
Oct-10
Jan-10
Apr-10
Jul-09
Oct-09
Jan-09
Apr-09
Jul-08
Oct-08
Jan-08
Apr-08
Jul-07
Oct-07
Chart 47: Raia Drogasil Historical EV/EBITDA
20
35.0x
6.0x
18.0x
25.0x
29.0x
18
16
25
+1 Std.
20
Avg.
15
-1 Std.
10
RADL3 EV/EBITDA
High
Low
Average
Current
2014 Target P/E
Jan-07
Chart 46: Raia Drogasil Historical P/E
40
Apr-07
Oct-06
Jan-13
Apr-13
Jul-12
Oct-12
Jan-12
Apr-12
Jul-11
Oct-11
Jan-11
Apr-11
Jul-10
Oct-10
Jan-10
Apr-10
Jul-09
Oct-09
Jan-09
Apr-09
Jul-08
Oct-08
Jan-08
Apr-08
Jul-07
Oct-07
Jan-07
Apr-07
Oct-06
0
14
+1 Std.
12
Avg. Excl Jul 08 to Jun 09 = 11.1x
Avg.
10
8
High
Low
Average
Current
2014 Target EV/EBITDA
6
4
2
-1 Std.
18.0x
3.0x
10.5x
14.0x
16.0x
18
Mar-13
Sep-12
Dec-12
Jun-12
Mar-12
Dec-11
Jun-11
Sep-11
Mar-11
Dec-10
Jun-10
Sep-10
Dec-09
Mar-10
Sep-09
Jun-09
Dec-08
Mar-09
Sep-08
Chart 49: Brasil Pharma Historical EV/EBITDA
High
Low
Average
Current
2014 Target P/E
20
Jun-08
Chart 48: Brasil Pharma Historical P/E
22
Mar-08
Jun-07
Dec-12
Mar-13
Jun-12
Sep-12
Dec-11
Mar-12
Sep-11
Jun-11
Mar-11
Sep-10
Dec-10
Jun-10
Mar-10
Sep-09
Dec-09
Jun-09
Dec-08
Mar-09
Jun-08
Sep-08
Dec-07
Mar-08
Jun-07
Sep-07
Dec-07
0
5
16
21.0x
10.5x
17.5x
16.0x
19.5x
High
Low
Average
Current
15
+1 Std.
Avg.
16
-1 Std.
14
12
BPHA3 Forward EV/EBITDA
RADL3 P/E
21.0x
2.5x
8.0x
6.8x
9.0x
5
5
BPHA3 P/E
High
Low
Average
Current
Sep-07
PFRM3 P/E
35
46.5x
3.0x
15.0x
40.0x
58.0x
PFRM3 EV/EBITDA
High
Low
Average
Current
2014 Target P/E
45
14
13
15.0x
7.0x
12.0x
11.0x
13.0x
+1 Std.
12
Avg.
11
-1 Std.
10
9
8
7
May-13
Apr-13
Feb-13
Mar-13
Jan-13
Dec-12
Nov-12
Oct-12
Sep-12
Aug-12
Jul-12
Jun-12
May-12
Apr-12
Mar-12
Feb-12
Jan-12
Dec-11
Oct-11
Nov-11
Sep-11
Aug-11
Jul-11
Jun-11
Apr-13
6
May-13
Feb-13
Mar-13
Jan-13
Dec-12
Nov-12
Oct-12
Sep-12
Jul-12
Aug-12
Jun-12
May-12
Apr-12
Feb-12
Mar-12
Jan-12
Dec-11
Oct-11
Nov-11
Sep-11
Aug-11
Jul-11
Jun-11
10
June 13, 2013
Main Risks
M&A Is the Key Driver to Consolidation but May Impose Dilution and Integration
Risks. Intense M&A activity triggered by listed and non-listed players should be the
main driver for the next wave of consolidation in drug retail, which may imply: (i)
dilution risks as growing competition for the remaining assets could lead the
companies under our coverage to overpay future acquisitions; and (ii) further
integration risks as cumulative acquisitions amid the integration of past purchases
could sequentially postpone synergy and scale gains.
Execution/Integration Risks. All companies under our coverage have a significant
pipeline of store openings to be carried out over the next three years, which could
raise execution concerns. As fragmentation slowly wanes, top management from the
companies should encounter several challenges that could ultimately reduce returns to
shareholders, such as: (i) lack of attractive retail locations to open new outlets; (ii)
entry in unexplored markets with different dynamics; (iii) integration hurdles arising
from sequential acquisitions; and (iv) lack of workforce.
Competition Could Heighten as Consolidation Unfolds. The consolidation story that
we expect to witness over the coming years will produce several outcomes in terms of
competitive strategy. Each contender’s aggressive expansion plans should eventually
lead large chains to encroach on each other’s turf, forcing the drug retailers to pass on
to consumers any potential discounts negotiated with suppliers, which could
negatively affect margins. Besides pricing pressures, fiercer competition could also
imply fewer points of sales available and lack of skilled personnel, further contributing
to profit-margin erosion. In the distribution segment, greater consolidation amongst
drug retailers may reduce distributors’ bargaining power, yielding significant
compression to operating profitability.
Regulatory Risks. The pharmaceutical industry in Brazil is highly regulated and is
subject to annual price adjustments from Brazil’s Sanitary Inspection Agency (ANVISA).
ANVISA’s price adjustments are usually set in-line with headline inflation, but both
retailers and distributors may be negatively impacted if the government uses this
regulatory mechanism to curb inflationary pressures. ANVISA also regulates the sale of
prescription and OTC drugs, which could undergo transformative changes in the shortterm (i.e. in 2010, all OTC products were required to be held behind the counter),
adversely limiting both retailers’ and distributors’ sales growth potential.
Balance Sheet Risks. Some companies under our coverage are committed to an
inorganic expansion strategy, which could lead to substantial cash consumption and/or
debt issuance to accommodate further acquisitions. If purchased assets fail to deliver
the expected returns, companies could face financial concerns that might reduce
available resources to be deployed into organic expansion.
Sudden Exit of Key Managers Who Leave With Essential Know-How. The M&A flurry
that established the operations of most companies under our coverage also led to the
assembly of top-and-middle managers that came from acquired companies. These
operating partners carry a great degree of operating know-how that is key to longterm execution of organic expansion plans. If operating partners leave before
expected, top managers that rely on their expertise may have a tough time rebuilding
an expert team or delivering a strategic plan.
Macroeconomic Risks. Differing from North American and European markets,
pharmaceutical industry in Brazil is heavily driven by out-of-pocket expenses.
Consequently, if any severe macroeconomic downturn impacts consumers’
discretionary income growth prospects, companies under our coverage could face
considerable top-line headwinds.
June 13, 2013
Industry Comps
Below we examine comparable data for the listed and non-listed drug retailers with
most similar characteristics: Raia Drogasil, Brasil Pharma, Pacheco São Paulo and Pague
Menos. Profarma’s retail operations lack sufficient data and track record to be
included in this analysis.
Chart 50: Number of Stores
Chart 51: Gross Revenues
5,594
864
4,975
708
585
515
494
400
301
3,949
R$million
673
# of Stores EoP
708
682
3,894
3,249
3,094
2,661
2,486
2,235
292
1,551
921
Raia Drogasil
Pacheco São Paulo
2008
2009
Pague Menos
2010
2011
Raia Drogasil
Brasil Pharma
Pacheco São Paulo
2008
2012
2009
Pague Menos
2010
2011
Chart 52: Average Gross Sales per Store/Month
Chart 53: Gross Margin - % of Gross Sales
586
575
524
465
448
499
429
466
463
387
299
Raia Drogasil
Pacheco São Paulo
2008
2009
Pague Menos
2010
2011
Gross Margin - % of Gross Sales
Avg. Monthly Sales per store - R$ '000s
26.7%
22.1%
2012
28.0%
27.1%
Pacheco São Paulo
Pague Menos
2008
2011
2009
30.2% 30.6%
22.1% 23.2%
21.0%
Raia Drogasil
Brasil Pharma
24.7%
23.7%
Brasil Pharma
2012
2010
Brasil Pharma
2012
Chart 54: SG&A Expenses
Chart 55: SG&A Expenses - % of Gross Sales
R$million
1,057
785
727
451
454
385
276
Raia Drogasil
Pacheco São Paulo
2008
782
700
2009
234
Pague Menos
2010
2011
2012
Brasil Pharma
SG&A - % of Gross Sales
1,168
25.4% 25.3%
20.9%
18.1% 18.4%
Raia Drogasil
21.6%
20.2% 21.3%
17.8% 17.2%
17.1%
Pacheco São Paulo
Pague Menos
2008
2011
2009
2010
Brasil Pharma
2012
June 13, 2013
Chart 56: EBITDA
Chart 57: EBITDA Margin - % of Gross Sales
288
247
R$million
219
175
166
145
104
100
74
44
Raia Drogasil
Pacheco São Paulo
2008
2009
Pague Menos
2010
2011
EBITDA Margin - % of Gross Sales
326
Brasil Pharma
7.6%
6.5%
5.6%
5.8%
5.8%
4.0%
4.8%
4.8%
4.5%
3.9%
Raia Drogasil
2012
Pacheco São Paulo
2008
2009
Pague Menos
2010
2011
Chart 58: Net Income
Chart 59: Net Margin - % of Gross Sales
151
117
R$million
107
91
79
73
50
41
Pacheco São Paulo
2008
2009
Pague Menos
2010
2011
2012
Brasil Pharma
Brasil Pharma
2012
3.8%
3.3%
3.0%
2.8%
3.3%
2.3%
1.7%
1.9%
2.0%
0.7%
0.1%
7
1
Raia Drogasil
Net Margin - % of Gross Sales
154
5.4%
Raia Drogasil
Pacheco São Paulo
Pague Menos
2008
2011
2009
2010
Brasil Pharma
2012
June 13, 2013
News From the Operating Front
Profarma
The main theme for Profarma now will be the diversification into retail. In our view, the
move to retail was necessary, as Profarma was being squeezed out by the large retail
chains that went on an M&A spree in the past few years. In this section, we depict
Profarma’s struggle in the distribution business and then we explore the opportunities
that lie ahead in an integrated model. Due to Profarma’s lack of track record in the
retail industry, we base our analysis on our knowledge of the listed peers, mainly Brasil
Pharma, which had a similar business model when it was created. However, we believe
that Profarma will enjoy some competitive advantages when compared to Brasil
Pharma’s case as it has better knowledge of the available assets and it may extract
synergies from the integrated retail/distribution model.
Drug Retail: An Unexpected but Necessary Move
From our perspective, Profarma’s journey into retail is a smart and bold move to
assure its long-term prospects. Late in 2012, Profarma surprised the market by
acquiring two drugstore chains in Rio de Janeiro state, initiating the company into a
mixed model of drug distribution-retail, which is commonly seen throughout Europe
though still rare in Brazil. We welcome Profarma’s entrepreneurial vision as we
understand that this strategic repositioning was the most practical way to keep on
growing at double-digit clips. Profarma had already depleted most of the distribution
market’s organic growth potential, and consolidation prospects in this industry should
take generations to unfold.
Market Cap/Tangible
Assets
Chart 60: Market Capitalization and Tangible BV of Global Drug Distribution Peers
1.5
1.0
0.5
0.0
2007
Profarma
2008
2009
Amerisource
2010
Cardinal
2011
Celesio
2012
McKesson
Source: Companies, Bloomberg and Brasil Plural Research
Drug retail should be a key source of accretive diversification for Profarma’s business
model. We see significant opportunities for Profarma as the largest drug distributionretailer player in Brazil, based on: (i) the drug retail consolidation story and its highgrowth, superior-margin profile; (ii) improved capital allocation possibilities; (iii) the
opportunity to stabilize results by reducing distribution’s earnings volatility.
June 13, 2013
Chart 61: Market Share Top 3 Distributors and Top 3 Retailers
+14p.p.
High
100%
42%
90%
40%
Small chains and independent outlets
rely heavily on distributors and
represent a sizable share of retail sales
80%
+12p.p.
35%
28%
30%
29%
70%
60%
25%
20%
Reliance on Distributors
Market Share Concentration (%)
45%
Chart 62: Pharmaceutical Sales per Sales Channel
50%
17%
40%
15%
30%
10%
20%
5%
10%
0%
Top 5 Retailers (ABRAFARMA)
2006
Low
0%
2004
Top 3 Distributors (IMS)
2011
2005
2006
ABRAFARMA Top 10
Source: ABRAFARMA, IMS and Brasil Plural Research
2007
2008
Supermarkets
2009
2010
Other Chains
2011
2012
Independents
Source: ABRAFARMA and Brasil Plural Research
The mixed distribution-retail model opens up much more profitable capital
allocation prospects than the limited opportunities in distribution alone. Distributors
are enrolled in the task of holding inventories early in the logistical process of the
pharmaceutical supply chain, unburdening laboratories’ working capital structure, and
providing credit to retailers in an attempt to increase its clients’ sales. Even though this
is the nature of the distribution business, it often leads to sub-optimal capital
allocation results, as the highly concentrated manufacturers are increasingly tightening
receivables conditions and small retailers are commonly not reacting to the expected
surge in sales that justifies extended payable terms. By moving to drug retail, Profarma
has the incremental options of deploying capital in opening new drugstores, enhancing
of its drugstores’ inventory before price adjustments or acquiring smaller drugstore
chains. In our view, the broadening of capital allocation possibilities imply in greater
likelihood of more profitable ROICs going forward, although we expect these to surface
only by the time drug retail becomes a more significant earnings contributor within
Profarma.
Chart 63: Profarma’s Capital Allocation Expansion in the Integrated Model
Capital
Allocation
DISTRIBUTION
RETAIL
INTEGRATED MODEL
Drugstore
REINFORCE RETAIL’s
WORKING CAPITAL
Distribution
Retail
Provide Credit to
Independent Retailers
Drugs tore
Distribution Center
 Likelihood
Medium
 Return
Medium
Independent
 Likelihood
High
 Return
Low-High
M& A
 Likelihood
Small
 Return
Low
 Likelihood
High
 Return
High
Drugstore
New Stores
 Likelihood
High
 Return
Medium-High
Drugstore
M& A
 Likelihood
High
 Return
Medium-High
June 13, 2013
Profarma is still a “show me” story: moving to retail was more of a survival move
than an option, but it still carries execution risks. Over the past few years Profarma
saw its revenue growth stagnate as drug retail underwent a fast consolidation process.
As a result, drug distributors came under pressure as retailers strengthened their
bargaining power and became less dependent on the funding from distributors to
overcome working capital needs. Consequently, they started demanding higher
discounts from distributors or started buying directly from the pharmaceutical
companies. We thus welcome Profarma’s move into retail, as the outlook for
distribution remains challenging as consolidation of retail should continue. However,
this strategy involves risks. In our view, the two most important risks are: 1) negative
impacts on distribution revenues once Profarma’s existing client base may start to see
the company as a competitor and may shift orders to other suppliers; 2) lack of track
record on retail and M&A, as retail is a whole new business for Profarma and the
company did not succeed in carrying on the consolidation of the distribution segment.
In the case of M&A, we believe that if Profarma improves its capital structure it has
good chances of delivering on M&A, as main competitors for acquisitions are now
distracted. And we try to incorporate the risk of losing clients and revenues in the
distribution business by having very conservative top-line growth for this segment
(Chart 64).
Chart 64: Profarma’s Distribution Segment Gross Revenues
6,000
5,000
R$million
4,000
3,000
2,000
1,000
0
2008
2009
2010
2011
2012
2013E
2014E
2015E
2016E
2017E
2018E
Distribution Is Huge, but Retail Is Sweeter
We believe Profarma will reach a mixed model in the foreseeable future in which its
current distribution operations will represent the majority of sales, while retail will
contribute with a larger share of operating profits. We are constructive on Profarma’s
retail potential, but drastic improvements in consolidated figures should take a while
to unfold. We estimate that distribution will remain as the company’s core business,
representing approximately 65% of Profarma’s gross revenues by 2017, while
contributing with 40% of operating profits. Attractive margins in the retail market
dictate this dynamic as we see EBITDA margins of 5-7% in drugstores, versus EBITDA
margins of 2-3% in the distribution division. As a result, we believe it is in the
company’s best interests to increase its drug retail presence throughout Brazil.
Profarma plans to acquire more existing drugstores and build its network through
regional expansion in a similar fashion to Brasil Pharma. When shopping for
drugstore chains to purchase, Profarma analyzes several aspects, such as size (in terms
of revenue per store), region, attractiveness of customer base, and the possibility to
smoothly convert ownership without disturbing daily business. In our view, this last
factor is crucial as Profarma’s management is currently assembling a team to
spearhead retail operations, and skilled regional managers should be a good starting
point. In addition, Profarma’s 12 distribution centers located in strategic regions of
Brazil, cover 90% of the country’s pharma market and grant the company with a deep
June 13, 2013
knowledge of particular drugstores that could become targets. There are still some
undefined strategies and targets that Profarma should deploy in its retail endeavor,
but we believe the company will follow a similar path to Brasil Pharma.
450
100%
EBITDA (R$million)
400
80%
350
57.7%
300
58.3%
58.8%
60%
250
50.8%
200
100
50
40%
33.6%
150
20%
7.5%
0.0%
0
0%
2012A
2013E 2014E
Distribution
2015E
2016E
Retail EBITDA as % of Total EBITDA
Chart 65: Retail to Represent 50% of EBITDA by 2015
2017E 2018E
Retail
Source: Profarma and Brasil Plural Research
Distribution division’s uninspiring growth and margins should keep on, though we
expect Profarma to remain as one of the top 3 players in this industry. Profarma’s
drug distribution business has been suffering from exhaustion of growth opportunities
as a result of the recent intra-chain consolidation in retail. In our view, as these retail
chains gets larger, the use of third-party distributors is less likely -- reducing
distribution market growth. Nonetheless, we still believe distribution will endure in the
coming years, although with a lackluster growth outlook that is unsupportive to
operating margins. Profarma should continue to rank among the top 3 distributors in
Brazil, seeking to seize the opportunities that are still available, such as: (i) increase the
share of generics and CFT products (greater margins) within its sales mix (see chart 65);
and (ii) growing its side businesses that yield greater margins such as the hospital and
specialties segment.
Integrated Model: When 1 + 1 = 3
We believe Profarma’s mixed model will generate accretive value through superior
cash cycle. In our opinion, becoming a vertical player will allow Profarma to capture
short-term synergies for its retail operations, such as best purchasing terms and
optimized logistics, IT, and back-office infrastructures. On top of this low hanging fruit,
we expect the great advantage from the mixed model to come from the competitive
edge its retail outlets will command in terms of working capital. Pharmaceutical
retailers operate with a high inventory level, balancing purchases to accommodate
good negotiating terms and expected demand. By relying on a mixed model, Profarma
will be able to operate its retail outlets with a significantly lower inventory level,
freeing working capital without compromising services quality. Chart 66 shows a
comparison between business-model returns and our estimate that each one-day
reduction in inventories results in a 20bps accretion to ROIC. If we consider that Raia
Drogasil and Brasil Pharma’s inventory levels is virtually double that of Profarma’s, we
estimate that Profarma’s integrated retail operations should yield greater marginal
ROICs – when stores are mature - than its listed peers.
June 13, 2013
Chart 66: Pharma’s Business Models Returns
(% of gross revs)
Gross Revs.
Deductions
Net Revs
COGS
Gross Profit
Gross Margin
Selling
Depreciation
EBIT
EBIT Margin
Distribution
100.0
-15.0%
85.0
-79.0%
6.0
6.0%
-1.8%
-0.2%
4.0
4.0%
Retail
100.0
-4.2%
95.8
-70.7%
25.1
25.1%
-16.0%
-1.9%
7.2
7.2%
Mixed Model
100.0
-10.7%
89.3
-75.7%
13.7
13.7%
-7.5%
-0.9%
5.3
5.3%
NOPAT(@34%) [a]
2.6
4.8
3.5
Invested Capital [b]
Capex
PP&E % of GR
Working Capital
Cash Cycle Days
Receivables
Days
Inventory
Days
Suppliers
Days
ROIC [a/b]
-16.1
-1.3
-1.3%
-14.8
54.4
13.8
49.5
11.8
53.9
10.8
49.0
16.4%
-17.4
-8.0
-8.0%
-9.4
39.0
5.8
21.0
15.7
80.0
12.2
62.0
27.5%
-14.5
-4.0
-4.0%
-10.5
37.8
10.6
38.1
11.3
53.9
11.4
54.2
24.1%
Pharmaceutical products distribution and retail are typically a high-volume/lowmargin business, where scale play a major role in driving profitability and a mixed
model may yield improved ROICs dynamic. Within the pharma value chain,
distributors are essentially the middle-man, granting manufacturers the access to
thousands of drugstores nationwide though the management of a complex logistical
and valuable data network. As a result, distributors’ operating margins are compressed
by manufacturers’ great bargaining power and retail outlets’ low perception of value
addition. In our view, value generation in this supply-chain is chiefly driven by scale,
which corroborates with our expectation of further consolidation, particularly in retail.
Large drugstore chains are able to negotiate superior purchasing terms based on
volume, besides absorbing fixed costs more effectively. On the flipside, scale gains in
distribution are more limited as drugstores generally work with several distributors,
reducing bargaining power in spite of building scale. However, we see accretive ROIC
opportunities stemming from the mixed model proposed by Profarma.
Distribution Market Is Under Pressure
The cyclical pendulum of the pharma business swinging against distributors: the
recent consolidation of drug retailers has led to stagnant top-line growth and
compressed margins. Over the past few years, Profarma saw its drug sales to retail
growth tumble from a 12.7% CAGR in the 2005-2010 period to flat in 2011 and 4.9% in
2012. This decline happened in tandem with the consolidation of the retail market, and
we believe that Droga Raia’s longstanding partnership with Profarma is a good
illustration of the deep changes that happened in the relationship between the large
drugstore chains and distributors. Prior to its IPO in December 2010, Raia Drogasil used
to have a leveraged balance sheet and counted on distributors to fund its working
capital needs. Back then, Droga Raia used to work with an average 90 days of suppliers
and its most important supplier was Profarma. Following its IPO, the company decided
to revise the terms with suppliers, reducing the average number of days outstanding in
exchange for better price conditions. At first, we believed that the working capital
released from the decline in Raia Drogasil receivables could be directed to fund small
mom and pops and with a positive effect on margins. However, the impact on margin
June 13, 2013
was below expectations, while sales growth remained low. Management saw a great
potential for consolidation in the Brazilian distribution segment as the top 3 players
held 42% market share vs. roughly 92% in the US. As a result, Profarma decided to try
and consolidate the distribution market.
80%
70%
60%
Growth in generics and non-drugs have
been overshadowed by stagnant
performance in branded and OTC drugs
50%
40%
30%
20%
10%
2012
2011
2010
-20%
2009
-10%
2008
0%
2007
YoY Sales Growth per Category (%)
Chart 67: Profarma’s YoY Sales Growth Breakdown
-30%
Branded
Generic
OTC
Non-Drug
Why Profarma’s attempt to consolidate the distribution market failed. In our view,
the consolidation of distribution is not as obvious as the consolidation of retail, which
we believe makes more sense as the acquirers pay for the retail locations. In the case
of the distribution companies, there is a large overlap between the clients of the large
nationwide companies and the ones from regional players, and neither the retailers
nor the pharmaceutical companies want to concentrate their sales in the hands of only
one or two suppliers. As a result, we believe that the consolidation of the distribution
market only makes sense when a distributor has very little market share in a given
region, which was the case in Profarma’s acquisitions up until 2007 (chart 68). The
Brazilian pharma distribution market has three main nationwide players: Santa Cruz,
Panarello, and Profarma. There are also a few regional players and a large group of
smaller distributors. However, Profarma already serves about 50% of the drugstores in
Brazil, which represent 90% of the addressable market. After suffering with the
consolidation of the large retail chains, which led to stagnant top-line growth,
Profarma attempted to act as the consolidator of the distribution market. Profarma’s
consolidation endeavor started with the large nationwide peers, with no success. Then
it went for the regional players, and still no success as we believe the vast majority of
small distributors still fail to see the likelihood of enhanced efficiency and expanded
margins that consolidation could generate through rationalization of distribution
centers and processes improvement.
June 13, 2013
Chart 68: Profarma’s Acquisition Track Record
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Arpmed
Distribution
Prodiet
Dimper
(RS)
Retail
Drogasmil
+
Tamoio
K+F (SP)
1999
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013E
Gross Revenues (R$million)
After the failed attempt to consolidate the distribution market, Profarma moved on
and decided to diversify into new segments and finally into retail. Profarma’s first
reaction to get over the failed attempt to consolidate the retail distribution segment
was to diversify into the specialty distribution market through the acquisition of
Prodiet in October 2011. With Prodiet, Profarma increased its presence in the
hospital/vaccines segment and set foot in the public segment. The initial results were
encouraging, with a pickup in top-line growth (accelerated to 22% in 1Q12 from 2% a
year ago) and positive effect on margins (up 70bps YoY). However, Profarma suffered
from the cyclical change in the public segment that happens during election periods,
which undermined the initial positive effects of the deal beginning in 4Q12. Profarma’s
second endeavor into diversification was more emblematic as an anticipation of the
move into retail. With the acquisition of Arpmed in July 2012, Profarma entered the
specialty retail market, offering high-ticket prescription drugs to the final consumers
through call centers in the cities of São Paulo, Rio de Janeiro and Campinas. Despite
the strategic importance, Arpmed is a relatively small operation and had very little
impact on Profarma. Finally, Profarma made the move into retail, with the acquisitions
of Tamoio and Drogasmil/Farmalife.
Raia Drogasil
The main themes for Raia Drogasil on the operating front are its ongoing integration
and organic expansion plan, which we believe will be the ultimate intrinsic value drivers
for the company. In addition, we also highlight Raia Drogasil’s newly announced pilot
stores targeting the low-end market under the brand Farmasil. In our view, Raia
Drogasil’s brand architecture may be a hidden value that could bring additional upside
in terms of intrinsic valuation, as well as an increase in the appeal of the asset in a final
round of consolidation.
Update on Integration: Toning Down High Hopes
Raia Drogasil underwent a transformational merger and the final outcome of the
integration process will be crucial for finding the fundamental value of the company.
In our view, the company is still best in class, but investors have created high
expectations from the merger. Raia Drogasil is the largest drugstore chain in Brazil,
reaching such a prestigious position through a bold merger between Drogasil and its
direct competitor Droga Raia. The deal was announced in July of 2011, and was highly
praised by a market that cheered for abounding synergies from a more robust player
that would combine Drogasil’s execution prowess and Droga Raia’s aggressive
expansion plans. We are now almost two years into the merger and integration
hurdles have kept Raia Drogasil from showing its true potential. In this section we
June 13, 2013
direct our analysis on Raia Drogasil’s current integration agenda and answer if the
market was indeed overly optimistic and if pre-paying synergy gains may not bear fruit.
The merger brought in high hopes, backed by a top-notch management team. Recent
numbers from The Street suggest that the initial euphoria is giving in to more
realistic expectations. Upon the merger announcement, Raia Drogasil’s newly formed
management team refrained from quantifying the potential synergies of the deal.
However, it disclosed several post-merger integration efforts that would be supported
by renowned consulting companies. Measures included the creation of an integration
office, the selection of a unified management system, purchasing & trade marketing
integration, and others that were aimed at capturing best practices of each standalone
company and to take advantage of the increased bargaining power. Yet, The Street’s
expectations were high, calling for: (i) greater sales prospects, based on optimization
of store portfolio; and (ii) improved operating margins, triggered by best purchasing
conditions, ramp-up of sales/store and efficiency gains at the SG&A level.
Chart 69: Expected Synergies Still to Be Seen…
Revenue Growth
•Best practices in sales; share of existing product and promotional
agreements; joint e-commerce platform
Gross Margin
•Best purchasing conditions and gross margin policies; enhancement of
trade marketing through best practices and reassessment of promotional
spaces; introduction of private label products
Efficiency Gains
•Strengthening of management structure; logistics optimization through
complementary DCs and improved shipping; integration of systems and
processes; corporate expenes dilution and redundancies elimination
Selected M&A
Store Portfolio Optimization
•Flexible capital structure; potential use of shares as a currency for
acquisitions; experience in M&A and PMI; empowerment of acquired
assets by the use of Raia-Drogasil dual-brand strategy
•Coordinated growth in existing markets; accelerated entry into new
markets; gains from selective closure of redundant stores
Source: Raia Drogasil and Brasil Plural Research
Non-recurring impacts from the integration process still make synergies hard to
quantify. In our view, both Drogasil and Raia had very sound expansion plans
underway when the merger was announced, and management was agile in adapting to
a new and coordinated strategy leveraging on a dual-brand strategy. As a result, Raia
Drogasil was able to meet expectations for sales performance, although SSS might
have disappointed in one quarter or another. On the other hand, the downward trend
in EPS estimates tells us a different story. Expectations of greater operating
profitability fell short of what was delivered, mainly as a result of non-recurring
impacts, rather than synergies, related to the merger.
Chart 70:…While Several One-offs Appeared
Integration Expenses
2012
1Q13
Total
Cons ulting
-10.0
-0.8
-10.8
Juridica l a nd Lega l Advis ory
-8.8
-1.6
-10.4
Severa nce Expens es
-3.7
0.0
-3.7
Stores /Ra ia Office Clos ure
-4.5
-2.2
-6.7
Fa rmá cia Popula r Progra m
-3.4
-5.5
-8.9
Total
-30.4
-10.1
-40.5
Gros s Revenues
5,594
1,438
7,032
-0.5%
-0.7%
-0.6%
p.p. impa ct on EBITDA ma rgin
June 13, 2013
Management took a conservative approach towards synergies since day one, and the
market is gradually converging to more down-to-earth scenarios. Raia Drogasil’s
integration is an ongoing effort that we do not expect to end soon. As of 1Q13, most
overhead areas are already integrated, with a single headquarter, top management
and commercial department. However, all these accomplishments have been hindered
by a flurry of non-recurring impacts that led Raia Drogasil’s operating margins to
remain flat in the first year of operations as an integrated company. We believe these
one-offs related to the integration process should steadily reduce throughout 2013,
clearing the space for the long-awaited synergies to kick-in. The next steps in the
integration should be the complete integration of IT systems, with the phase-in of SAP
to all stores (currently only present in Raia). We remain skeptical of significant
synergies in the short-term as the assertive pipeline of store openings should keep
operating margins pressured, though brighter profitability outlook should emerge as
the company’s share of mature stores grows. Charts 71 and 72 show consensus
forecast evolution for Raia Drogasil’s sales and EPS.
Chart 71: Bloomberg’s Consensus Sales Estimates (R$million)
Chart 72: Bloomberg’s Consensus EPS Estimates (R$/share)
Store Opening Plan
Organic expansion through a well-coordinated store opening plan should be Raia
Drogasil’s playbook and one that we believe management’s know-how underpins. At
the time of the merger, Drogasil and Droga Raia were in different expansion phases.
Drogasil’s expansion plans were more modest (average of 35 stores/year), focusing on
driving profitability of its growing share of mature stores, while Droga Raia was in a
relentless process of launching new stores, with a plan to open 90 stores/year. In our
view, the merger combined Raia’s aggressiveness and Drogasil’s discipline, resulting in
a solid pipeline of store launches under the new umbrella. We believe Raia Drogasil’s
top management posses the experience to move through this phase, although we
highlight that the main risks for its expansion plans are related to personnel and
optimum use of its current and new distribution centers.
June 13, 2013
Chart 73: Pipeline of Store Openings – Guidance vs. Delivered
Chart 74: Distribution Centers Locations
Raia Drogasil reiterated its roadmap of 130 new stores in 2013, which should be
delivered around its seven distribution centers. Raia Drogasil delivered 100 new
stores in 2012, slightly below the initial 130-store guidance, mainly as a result of some
delays in openings using the Droga Raia brand on the back of the anticipation of the
corporate restructuring process on which Droga Raia was incorporated by Drogasil.
The incorporation helped assure the utilization of the fiscal benefits related to the
goodwill generated by the merger. The estimated value of the fiscal benefit from
goodwill is R$85 million. However, it delayed the store openings under the Droga Raia
brand due to bureaucratic requirements related to the store operation license, and it
also prevented the company from effectively using its distribution centers. As of 1Q13,
this issue is a shade of the past and Raia Drogasil is already back to the store opening
th
pace that resonates with the expected 130 target. The addition of its 7 distribution
center in 2012 to reinforce the position in the northeastern region also strengthens
execution achievability. Going forward, we believe Raia Drogasil should gradually ease
the pace of new shops, tactically developing new distribution centers as it drifts into
untapped areas.
While we remain confident on Raia Drogasil’s management execution prowess to
deliver expected store expansion, we grow concerned about personnel and
distribution center bottlenecks. Over the past couple of years, Brazil’s labor market
remains unexceptionally tight, rendering unemployment rates at all-time lows. This
macro dynamic has direct consequences to Raia Drogasil’s expansion plans as supply of
skilled labor is sequentially getting more expensive. Not only that, Raia Drogasil’s
distribution center encompasses the most relevant pharmacy markets in Brazil (see
chart 74). However, we expect growth prospects to slowly decelerate in these markets
and the expansion to north/northeastern regions will probably be the prescription for
further growth. We view this movement as natural and Raia Drogasil can use
distributors to slowly learn new markets, but we believe that Raia Drogasil’s operating
standards include building new distribution centers in these new regions, which could
also pose some execution risks and short-term pressures on operating profitability.
Multi-Brand Strategy: Raia Drogasil’s Hidden Value
Raia Drogasil brand architecture embraces two of the most prominent drug retail
brands in Brazil, bolstering the company’s expansion flexibility and empowering new
brand-building concepts. According to BrandAnalytics/Millward Brown, Drogasil and
th
th
DrogaRaia rank as the 38 and 43 most valuable brands in Brazil, respectively, and
are the only drug retailers making the study. We acknowledge the great deal of
relevance that convenience plays in drug retail, but we are defenders of a welldeveloped brand strategy that drives customer choice, loyalty and spontaneous
advocacy. Raia Drogasil’s multi-brand strategy yields adaptability to different market’s
demographics, maximizing market share gain/maintenance based on store
June 13, 2013
openings/closings, catering to brand-switchers and boosting the development of
alternative brands.
Chart 75: Raia Drogasil’s Brand Architecture
Chart 76: Raia Drogasil’s Geographic Presence
Markets with only
one brand should
remain with one
brand in the shortterm, while in mixed
markets, store
openings are analyzed
case-by-case
14
6
447 Stores
FD:45
63
458 Stores
74
7
17
524
66
46
Number of Stores
26
17
Source: Raia Drogasil and Brasil Plural Research; ¹Free translation; ²BrandAnalytics
From our perspective, brand architecture mastery provides optimization of current
store portfolio and will be pivotal in intra-chain confrontations. Upon the merger,
Raia Drogasil management inherited the largest portfolio of stores in the country (864,
as of December 2012), and quickly figured out that closing overlapping stores did not
necessarily channel sales to the residual store. In addition, intra-brand migration
between nearby stores is not always the case. In contrast, maintaining the dual brand
strategy helps to cater to brand switchers (consumers willing to experiment with
different brands). In this sense, we do not expect a significant number of closings going
forward, as we see Raia Drogasil’s store portfolio evolving with a healthy balance of
Drogasil/Droga Raia stores. As a matter of fact, we believe that a balanced assortment
of brand/stores should render Raia Drogasil with an extra push when a frontal clash
with other large chains becomes inevitable. While competitors hinge in different
regional brands to expand in the short-term, when drug retail advance from the “stateby-state” contest, they will most likely face Raia Drogasil’s two flagship brands as
national contenders rather than regional powerhouses.
Chart 77: Conceptual Example of Raia Drogasil’s Dual-Brand Prowess
2.5
1.8
Rebased at 100 at the
opening of new store
for comparatitve
purposes
1.6
2.0
1.5
1.4
1.2
Sales
Sales
Rebased at 100 at the
opening of new store
for comparatitve
purposes
1.0
0.8
1.0
0.6
Intra-brand cannibalization is
lower...
0.5
0.0
...upbolding the dual-brand
strategy superior marginal
revenue per new store
0.4
0.2
0.0
1
2
3
4
5
6
7 Time
8 9
10 11 12 13 14 15
1
2
3
4
5
6
7
Time
8
9
10
11
12
13
14
15
Drogasil is the spearheading brand in new markets, while Droga Raia comes in to
strengthen competitive market positioning. Management has been vocal about using
Drogasil stores when entering untapped markets, mostly due to the brand’s more
comprehensive store formats and popular appeal. Evidence of this strategy comes
from Raia Drogasil’s venture in four newly entered states (Bahia, Mato Grosso do Sul,
Mato Grosso and Santa Catarina), all of them receiving new Drogasil stores, which
should grow as the company keep its store opening plans. Once these markets are
saturated by competitors and Drogasil itself, Raia Drogasil can channel new store
openings to the DrogaRaia brand, filling different price and quality gaps. According to
June 13, 2013
management, this dual branding strategy allows for greater marginal revenue per new
store when compared to a monolithic expansion strategy (see chart 77). Lastly, Raia
Drogasil acknowledges markets’ singularities and if a more premium set is required,
DrogaRaia can be tactically used to fit specific needs.
Raia Drogasil unveiled a new brand and store format to tap emerging consumers,
which we see as positive in the long-term and inform us of management’s flexible
framework to take advantage of market opportunities. During its 1Q13 earnings
conference call, Raia Drogasil disclosed that they are carrying a pilot-program of
smaller and unembellished stores, focused on reaching out to consumers of lower
income brackets. The call here is for price, speed and assertiveness of a simple
portfolio of products. Granular details about this endeavor are scarce, but capex per
store should be way below current average, yielding lower sales/sqm as well. ROICs
are expected to be similar though. We understand that this movement is still too
embryonic to move the needle in the short-term, but it shows management willingness
to experiment with new brand concepts to seize market opportunities. In our view,
this could be a good way to respond to increasing competition from Pague Menos and
to a potential buyout of franchisees by Brasil Pharma, while at the same time it
increases Raia’s addressable market by 44%, or R$36 billion, as it traditionally catered
more to the A/B segment.
Chart 78: Going Down the Social Pyramid
0
5,000
10,000
15,000
Chart 79: Farmasil Store – No Stands, Straight to Generics
20,000
25,000
A1
Downselling
holds sizable
opportunities
in terms of
addressable
market
expansion
A2
B1
B2
C1
C2
D
E
Potential R$36 billion untapped market
Potential Consumption per Income Bracket (R$million)
Source: IPC and Brasil Plural Research
Brasil Pharma
The main themes for Brasil Pharma are also the update on integration and the organic
expansion plan. In addition, we also highlight the ongoing changes in the company’s
ownership and corporate structure as important developments that can dictate the
long-term performance of the company.
The Integration Dam
Brasil Pharma’s leadership in several markets was conquered through a wellentrenched acquisition culture, but it should only grasp its “power of one” potential
once all operations are fully integrated and a definite corporate structure emerges.
From our perspective, Brasil Pharma’s competently executed roll-up strategy led the
company to be well positioned in some of the fastest growing regions in the country,
ranking #1 or #2 in states in the southern, mid-western and northeastern regions of
Brazil. Brasil Pharma’s fulfilled its consolidation plan (see chart 80) as advocated in the
company’s IPO, reaching and expanding in less competitive regions with the help of
local expertise acquired from former regional operators. However, we believe Brasil
Pharma’s positive prospects are still blurred by the ongoing consolidation process (see
chart 81), primarily as a result of two game-changing deals – the acquisitions of Big Ben
and Santana -- on top of those that constituted the IPO’s roll-up.
June 13, 2013
Chart 81: Brasil Pharma Timeline
Rosário
Acquisition
800
300
384
397
Jun/2011
400
663
681
Mar/2011
Farmais
Acquisition
468
Jul/2010
500
May/2010
1Q13
709 Stores
Platforms
Big Ben/Guararapes
Sant’Ana
Mais Econômica
Rosário Distrital
1,017
824
Sep/2009
367 Stores
Platforms
Mais Econômica
Guararapes
Rosário Distrital
986
IPO
700
IPO (Jun/2011)
Follow-on
1,115
900
600
San'Ana
Acquisition
Mar/2013
1,000
Big Ben
Acquisition
Jun/2012
1,100
Mais
Economica
Acquisition
Brasil
Pharma
Inception
Feb/2011
1,200
Nov/2011
Chart 80: Concrete Delivery of Regional Expansion
# Stores (Proprietary + Franchises)
Source: Brasil Pharma and Brasil Plural Research
Brasil Pharma’s earliest roll-up business model aimed to capture synergies based on
a three step integration process: scalability, efficiency and consolidation. Back in
2009, BTG Pactual’s private equity arm conceptualized Brasil Pharma as a roll-up of
regional drugstore chains, first by purchasing a franchise operation in Sao Paulo
(Farmais) and subsequently acquiring Rosário (Midwest - Jul/2010), Guararapes
(Northeast - Oct/2010) and Mais Economica (South – Mar/2011). After the company’s
IPO in Jun/2011, top management’s integration process of different and geographically
sparse assets began, expecting to be concluded through three phases (see chart 82).
Chart 82: Management’s Integration Expectation
Scalability
Efficiency
Consolidation
(Expected: YE2011)
(Expected: 2H12-2H13)
(Expected: post 2H13)
• Procurement
integration
• IT, Culture
implementation
• G&A Synergies
• Best Practices
• Processes
Standardization
• Consolidation of
Operations
• Product Expansion
• Culture
Implementation
Subsequent acquisitions of Big Ben (Nov/2011) and Santana (Feb/2012) added two
sizable assets to Brasil Pharma’s umbrella, delaying tangible synergy gains beyond
initial expectations. Brasil Pharma’s management was expecting low-hanging fruits
from scale gains of combined assets, particularly in purchasing integration (COGS
reduction). The initial goal was to capture these gains within 6-12 months after the
IPO. However, the company’s mandate of regional expansion through M&A led to the
acquisition of Big Ben and Santana within that timeframe, ultimately forcing Brasil
Pharma to tactically adjust its integration agenda. Management decided to incorporate
Guararapes under Big Ben in light of the operations proximity, and as of 1Q13, Big Ben
procurement division is still not operating together with the rest of the commercial
platform. A similar reschedule is also happening in the implementation of Brasil
Pharma’s Shared Service Center (SSC), which is one of the company’s trumps in
delivering SG&A gains to offset its hefty regional management structure and close the
efficiency gap with its competitors.
June 13, 2013
Chart 83: Commercial Platform Integration and Shared Service Center
Implementation Schedule – Delivered and New Targets
Inte
1Q12
SHARED SERVICE CENTER IMPLEMENTATION
PROCUREMENT INTEGRATION
2011
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
SAP introduction led Brasil Pharma to promote
tactical adjustments.
Big Ben/Guararapes integration was rescheduled
in light of SAP introduction which should be
conducted in three steps...
Rosário
Sant’Ana
Mais
Econômica
Big Ben
Guararapes
SSC Preparation Corporate Structure
2014
Big Ben
Guararapes
SSC Stabilization,
Rosário + Farmais
Sant’Ana
Mais Econômica
Big Ben
Guararapes
SAP should be implemented in
three phases: (1) Back-office
(9M13E); (2) Inventory
Management (2H14E); (3) Store
Front (delivery undefined)
Delivered
Postponed
Big Ben
Guararapes
SAP
New Target
We acknowledge management’s efforts to tackle the challenges entailed in the
consolidation of Brasil Pharma’s complex structure, but we do not expect any
shortcut other than time to seize the “power of one”. We do not see above
mentioned postponements as indications of inadequate execution; we view the work
that has been done as fast, all things considered, and more importantly, we believe
that Brasil Pharma has actually worked actively to reduce the risk of the potential
departure of the operational shareholders by setting up a strong management team
with sound industry expertise. However, we believe there is still a time-consuming
path to grasp the expected synergies of a fully integrated Brasil Pharma. We draw
relevant insights from Raia Drogasil and its post-merger experience. In our view,
Drogasil and Droga Raia were two of the best managed drug retail assets in Brazil,
operating in virtually the same area, yet we struggle to notice material step up in sales
or profitability stemming from the merger. In sum, we expect Brasil Pharma’s
suboptimal results to gradually improve over time, particularly when structural
rewards from the integration start to kick in, but it should not happen in the near-term
and we gaze into 2014-2015 to get more constructive.
Chart 84: Integration One-offs Still Blur Integration Gains
Integration Expenses (R$million)
2011
2012
1Q13
Total
IPO/Bonds Is s ua nce Expens es
-2.1
-0.1
0.0
-2.2
M&A/Bra ndi ng
-4.1
-5.4
-0.7
-10.2
Pl a tform Integra ti on/Downs i zi ng
-4.3
-13.3
-1.8
-19.4
Ta x As s es s ment Fa rma i s
0.0
-3.9
0.0
-3.9
Other
-0.9
-1.4
-0.1
-2.4
Total
-11.4
-24.1
-2.6
-38.1
Gros s Revenues (R$mi l l i on)
2,558
3,094
815
6,467
-0.4%
-0.8%
-0.3%
-0.6%
p.p. i mpa ct on EBITDA ma rgi n
June 13, 2013
Homespun Solution to Build Cohesion
Brasil Pharma’s corporate structure is evolving into a mix of internally bred
leadership plus experienced industry professionals from what originally started as a
banking effort. In our view, Brasil Pharma’s top management is gradually growing past
its ties with former owners. Some of the better management that came along with the
various regional acquisitions have been critical to identifying organic growth
opportunities and future M&A targets. This evolving management team that has been
borne out of the roll-up is proving adept at capitalizing on the regional brand
awareness of the legacy chains and their strong store locations.
Chart 85: Brasil Pharma’s Diversified Middle-Management Enables the Simultaneous Engagement in Several Fronts
Regional singularities endorse the different approaches each team is tackling and we
expect a more cunning reaction if executed independently. Brasil Pharma’s roll-up
DNA has caused management to run a company with distinct platforms operating with
different routines and habits. While all the aforementioned efforts deal with internal
issues that should help Brasil Pharma surpass the integration dam, the employment of
regional divisions is aimed to face both internal and external particularities of each
market more swiftly. In our view, considering Brasil Pharma’s structure, this is a
constructive way to empower middle-managers to promote tactical adjustments en
route to accomplish their goals. We depict on Chart 85 each divisions’ feats and areas
to be improved.
The corporate strategy of retaining former owners as partners was a way to assure
execution and regional know-how, but it also entailed conflict of interest risks. The
company was developed with the discourse of leveraging on founding partners’
regional expertise to deliver superior execution and overcome peers who dare enter
their domain. While we believe it made sense from an operating standpoint in the
early stages of operations, in practical terms it associated Brasil Pharma’s success on
these managers’ willingness to take the consolidated company to the next level. This
was one of investors’ main concerns and push-backs during Brasil Pharma’s IPO and
one that top management pre-empted through the underlying intrinsic value of the
business and share lock-ups to founding partners that would ensure commitment and
interest alignment (see chart 86). Over the past two years, Brasil Pharma’s top
management promoted some adjustments to its middle-management, particularly in
executives spearheading the way out of the integration dam (see chart 87).
June 13, 2013
Chart 86: Before-After Corporate Structure
2011
2012
2013
2014
Jun/2011
Jun/2011
1st Tranche(Jun/12)
2nd Tranche(Jun/13)
3rd Tranche(Jun/14)
Feb/2012
2015
2016
Jun/2014
2.25mn shares
(0.9% total)
Jun/2014
7.86mn shares
(3.1% total)
15mn shares
(5.9% total)
Feb/2015
Mar/2012
Mar/2015
23.8mn shares
(9.4% total)
Chart 87: Before-After Corporate Structure
ADMINISTRATIVE/SHARED SERVICE
CENTER (SSC) INTEGRATION
COMMERCIAL
INTEGRATION
OPERATIONS
INTEGRATION
Procurement
Operations
Finance/SSC
Renato
Stefanoni
Rodrigo
Silveira
Sara
Rezende
Logistics
Trade
Marketing
North/
Northeast
South
Bahia
Platform
Mid-West
Projects
SSC
SAP/IT
Jadir
Tavares
Rovilson
Apolinário
Ricardo
Kitamura
Delmar
Raguzzoni
Renato
Lobo
Emílio
Azevedo
Juliana
Amaral
Alessandra
Araújo
Renato
Segala
Farmais: Far More a Rain Check Than a Free Option
With the growing likelihood of intra-chain combination amid the next wave of
consolidation, we believe Brasil Pharma’s franchising system – Farmais – is the
company’s most likely answer to join the fierce race for the southeast. Upon
inception, Brasil Pharma strategy was to avoid direct confrontation with larger, wellestablished chains in an attempt to deliver greater gross margins in light of lower
competition. As a result, Brasil Pharma’s cherry picked its acquisitions outside the
southeastern region, choosing instead to conduct a franchising model in the region
with the Farmais brand (see details in chart 88). We believe this move played a critical
role in the company’s competitive strategy as it is a cheaper way (no capex involved in
store openings) to tap emerging consumers in highly competitive areas without
moving the focus from its core operations. However, as we expect markets
fragmentation to wane over time, Brasil Pharma’s opportunity to revisit its long-term
strategy relies on the option to purchase Farmais stores from franchisees. In the past,
we viewed Farmais as a free option to enter the highly competitive and real estatescarce southeastern market. But ever since CVS acquired Onofre, we tend to view the
buyout of Farmais’ franchisees as a requisite before the final round of consolidation.
June 13, 2013
Chart 88: Farmais Number of Stores Evolution
1000
Brasil Pharma's Call
Option Contract
900
872
800
713
700
600
530
500
400
- When a franchisee
renews its contract, it must
sign with the call option to
Brasil Pharma.
- Franchisees are required
to renew their contracts for
each 5-year period.
361
300
2010
2008
2006
2004
2002
2000
0
#Stores with BPHA's Call Option¹
2016E
2012 79
100
2014E
199
200
- Brasil Pharma's call
option enables the
company to purchase
franchisees' stores for 1/3
of annual gross sales.
#Stores
Source: Brasil Pharma and Brasil Plural Research; ¹Brasil Plural estimates
Farmais’ franchise contracts include a call option in favor of Brasil Pharma, which
could ultimately anchor Brasil Pharma as the first true nationwide player and put the
company for good on the consolidation map. According to management, roughly 20%
of Farmais’ franchisees contracts have a call option that grants Brasil Pharma the
possibility to purchase the underlying store at 1/3 LTM sales. All new contracts and old
contracts renewals are being formulated with this call option embedded. The contracts
have a five year length, thus we expect Brasil Pharma to be entitled to purchase all
Farmais outlets by 2016-2017. We estimate that considering Farmais’ stores average
annual sales between R$0.8-2.5 million, Brasil Pharma could purchase an asset of 600+
stores for R$150-500 million. In our view, at 1.3x sales valuation (in line with Raia
Drogasil and Brasil Pharma at current market prices), the incorporation of Farmais
would be accretive as it would allow Brasil Pharma to become the most
comprehensive drug retailer in the country while positioning it as one of the most
coveted targets for international players.
88%
80%
60%
40%
20%
25%
20%
38%
40%
62%
50%
60%
75%
80%
Cat. 1
Cat. 2
Cat. 3
Cat. 4
Cat. 5
Cat. 6
Cat. 7
Cat. 8
R$1,267
R$592
R$377
R$237
R$134
R$70
R$35
R$10
0%
Avg.
Monthly
Sales
(R$'000)
100%
0%
Mkt. Share (R$)
Cummulative Mkt. Share (#Stores)
100%
100%
13%
Cummulative Mkt. Share (R$)
Chart 89: Farmais is Brasil Pharma’s Downscale Opportunity
Mkt. Share (#Stores)
Farmais expansion potential is based on the catering for a different target public
than Brasil Pharma itself and other drugstore chains, while also aiming to convert
independent stores to franchisees. In our view, independent of the strategic issues
surrounding Farmais, the franchising operation has some appealing opportunities on
its own. As we describe in Chart 89, Farmais is positioned in a cluster of the drug retail
market that is dominated by smaller stores that focus on lower income clients, hence
June 13, 2013
yielding a lower sales per store than Brasil Pharma, Raia Drogasil and Abrafarma. We
believe Brasil Pharma should be able to expand in this “mom and pop” territory also by
converting independent drugstores into Farmais, with the proposition of offering an
optimization package (superior commercial terms through centralized procurement,
trade marketing know-how, nationwide marketing campaigns) in exchange for monthly
fees (1.3% of gross revenues up to a R$1,530/month limit). Moreover, we view Farmais
as a great avenue for acquiring local market expertise. These independent operators
can fill some knowledge gaps, particularly in more sparsely populated areas where
low-income populations have tremendous loyalty to local owners.
June 13, 2013
Appendix: Key Industry Themes
Secular Trends Underpin Pharma Growth on Steroids
According to IMS Health, the Brazilian Drug retail market should expand by a CAGR of
14.0% during 2013-2017, a slight deceleration from the CAGR of 16.7% posted in 20082012, which compares to the global average of 6%. In our view, the core drivers for
such an upbeat forecast remain the growing purchasing power of the young Brazilian
population, reinforced by generics’ flourishing significance to consumers. We also see
major shifts in consumption pattern that could stem from public policies, which could
ultimately enhance growth prospects. In sum, we expect Brazil’s drug retail market to
keep outgrowing global market (’08-12 CAGR of 16.7%), making the case for Brazil’s
secular growth an appealing investment case.
2017E
2016E
2015E
2014E
2012A
2011A
2010A
2009A
2013E
IMS estimates
100
90
80
70
60
50
40
30
20
10
0
2008A
Pharma Sales (R$billion)
Chart 90: Drug Retail in Brazil Is Expanding at a Striking Pace in Global Terms
Source: IMS
Generics penetration is far from a matured stage. From our perspective, growing
penetration of generics within drug retailers’ mix will keep on fueling market growth in
Brazil, chiefly by expanding the addressable market and encouraging consumption
based on greater affordability. We expect drug retailers to keep pushing generics’ sales
upwards based on the healthier margins they yield and the long-term savings in the
expanding role of preventive medicine vs. hospitalization. Moreover, the growth in
generic penetration can be further spurred by the advent of other payers, such as the
government or Personal Benefits Manager (PBM).
Chart 91: Generics Penetration Dynamics Compared to the US
Suggests that Generics’ Price in Brazil are Still Much Higher
25%
80%
20%
70%
60%
15%
50%
40%
10%
30%
20%
5%
10%
0%
Generics Penetration (Value)
Generics Penetration (Volume)
90%
Chart 92: Generics’ Monetary Contribution Is Greater Than
Branded Drugs
0%
2006
BZ Volume (LHS)
2007
2008
US Volume (LHS)
Source: IMS and Brasil Plural Research
2009
2010
BZ Value (RHS)
2011
Generics' price are c.40% lower
than branded drugs, but yield
c.50% greater contribution margins
100
60
85%
50%
30
15
Branded
Drug Price
Cost
Contribution
Margin
Generic Drug
Price
Cost
Contribution
Margin
US Value (RHS)
Discounts and patent expirations should drive competition and pave further access
to generics. Competition in the supply side (laboratories) of the pharma value chain is
June 13, 2013
escalating at the same fast pace, driven by global enterprises seeking to tap the
prominent “Pharmerging” market Brazil has proved to be. Consequently, this
competitive landscape is leading to a sequential rise in discounts conceded to drug
retailers (see chart 93), particularly in the generics segment. Concurrently, we believe
that the noteworthy patent expiration pipeline (see chart 94) should incentivize labs to
offer generic counterparts at discounted prices to offset market share erosion.
Chart 93: Discounts Evolution per Type of Product
Chart 94: Drugs’ Loss of Exclusivity (LOE) Pipeline
3
+21p.p.
60.4%
60%
2.8
2.5
50%
2
39.2% 41.3%
40%
R$billion
Discounts Evolution (%)
70%
30.3%
30%
25.1%
16.2%
20%
8.3%
10%
1.7
1.5
1
20.2%
11.5%
There are at approximately R$1 billion in retail
market sales that are subject to loss of exclusivity
in the next three years
0.5
0
0%
Branded
Similar
2010
2011
Protected in LOE in 2013 LOE in 2014 LOE in 2015 LOE in 2016 LOE 2016 On
2012
Generic
2012
Structural social-economic drivers to keep the retail push. The same social-economic
factors that led the Brazilian pharmaceutical market to grow at a 17% CAGR over the
past five years, is likely to linger for the next couple of decades. In our view, these main
drivers consist of: (i) an aging population with poor income distribution, limiting access
to innovative therapies; (ii) growing purchasing power led by an out-of-pocket
spending reality that yet lags several emerging peers. According to IBGE’s latest
census, Brazil has been undergoing a demographic transition process. A decreasing
fertility rate coupled with longer life expectancy has reshaped the age structure in the
country, increasing the share of senior Brazilian citizens. Based on IBGE forecasts,
adults within the range of 40-80 years old should represent 39% of total population by
2030 compared to the current 24%. We believe this demographic shift tends to
increase pharmaceutical products consumption, mainly as a result of the still high
income inequality that reduces the access to proper therapies. Charts 95 and 96 shows
population age distribution and evidence from the US of greater pharma expenditure
as the population ages.
Chart 96: Pharma Expenditure per Age Group – US Evidence
40%
20
15
10
8%
10%
2000
2010
14%
19%
20%
5
-
0%
Population over 60yrs
Source: IBGE and Brasil Plural Research
2020E
2030E
% of Total Population
Rebased at 100 for
comparatitve purposes
507
377
233
100
161
Age Group
>75-years
25
65-74
Millions
30
791
680
55-64
60%
45-54
35
35-44
40
900
800
700
600
500
400
300
200
100
-
25-34
80%
<25-years
45
Pharma expenditure per capita
Chart 95: Brazil’s Population Age Distribution
Source: Health Distribution Management Association and Brasil Plural
June 13, 2013
Brazil’s out-of-pocket healthcare spending reality should continue to boost drug
consumption as social conditions improve. The 1988 Brazilian Constitution grants
every Brazilian citizen universalized access to equal medical care, supported by the
Government’s unified health system (SUS). The sector, however, receives only 41.6%
of its total resources from government funding, according to the World Health
Organization (WHO). Notwithstanding, the Brazilian economy has fared well as a result
of rising discretionary income and formal employment, and consequently so have the
emerging social classes, which should produce a significant impact to pharma
expenditure as social conditions improve (see chart 97).
Chart 97: Class C Should Boost Pharma Spending
Pharma Expenditure per Household per Social Class (R$/year)
A
Total Pharma Expenditure per Social Class (R$million/year)
A
4,303
B
B
1,894
C
Total pharma market can potentially
expand by 3% for each 10% of the
class C that emerges to class B
679
E
27,440
D
5,029
E
387
0
28,468
C
1,134
D
8,717
1,000
2,000
3,000
4,000
5,000
157
0
5,000
10,000
15,000
20,000
25,000
30,000
Source: Target Consulting and Brasil Plural Research
June 13, 2013
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Copyright 2013 Brasil Plural CCTVM and/or its affiliates. All rights reserved.

Roadmap for Consolidation Initiating Coverage

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