We should all be Neighbourly
Neighbourly Pharmacy is Canada's fastest growing independent pharmacy chain
Neighbourly Pharmacy (NBLY.TO) is a chain of Canadian pharmacies which has emerged as a nationwide drug store chain comprising 275 stores including 100 acquired just last month. The acquired chain of 100 dispensaries (largely in smaller communiites and clinics) was formerly known as Rubicon.
Pharmacies are an odd retail business since the bulk of the profit margin comes from fees paid to pharmacists to dispense prescription drugs. The typical fee in Canada is $8.87 for drugs listed in the Provincial Formulary and paid for by the Ontario Drug Plan and from $10.99 (Loblaws and Metro) to $12.99 (Rexall), although dispensaries in Costco stores charge only $4.99 per prescription. As the founder of the modern Rexall Drug Store chain (I held it a subsidiary of Algonquin Mercantile Corporation which I controlled at the time and sold the chain to Daryl Katz’s Katz Industries in 1996 when it operated 36 stores) I am familiar with the economics of a typical drug store.
Neighbourly filled 1.9 million prescriptions (or “scripts” as they are often referred to in the trade) in the last quarter before the Rubicon acquisition, and I estimate the Neighbourly chain will fill about 12 million scripts in its next fiscal year. At an average of $10 fee per script, dispensary margin will be at least $120 million. Eighty percent of Neighbourly’s revenue is from its dispensaries, with 20% from what is referred to as the “front store”. Front store margins are typically about 30% of sales.
Each of Neighbourly’s 275 drug stores can be reasonably expected to have revenues of about $2.6 million annually, so the expanded chain should enjoy revenue of $700 million or so. Since Neighbourly has been growing through acquisition, reported results include substantial “goodwill” and amortization of intangibles and analysis of results is muddied by the accouting for such costs. Notwithstanding, EBITDA of 10% to 12% of sales is in the ball park of reality, so I expect to see EBITDA of $85 to $95 million for the next full year, and project same store sales growth to be in the 2% range for the next few years (possibly higher owing to the rising level of inflation).
A sensible valuation for a drug store chain is 10 times EBITDA putting a representative value on NBLY of ~$900 million. Deduct debt of $300 million and the common shares have an approximate value of $600 million, or about $14 a share for the 44 million shares outstanding. The shares currently trade in the $20 range.
Think the shares are overvalued? Conventional analysis would agree. I don’t.
The company’s corporate presentation discloses an adjusted EBITDA of $95.5 million and a robust acquisition pipeline. Canada has some 11,000 pharmacies and 6,400 of these are independently owned. Neighbourly’s strategy to grow through acquisitions and benefit from economies of scale in purchasing, logistics and point of sale systems is the right one. Markets have tended to undervalue pharmacy chains for decades, ignoring the stability of their operations and the steady growth in demand for prescription drugs driven by demographics. Canada’s population is growing and aging.
I am reminded of the history of Shoppers Drug Mart which was at one time owned by Imasco and at that time operated 650 stores nationwide. Imasco sold Shoppers to a unit of KKR for $2.5 billion in 1999. KKR took Shoppers public for double that price and in 2013 Loblaw’s acquired Shoppers for $12.4 billion. I believe the acquisition has been a tremendous success for Loblaws.
Katz’ acquisition of Rexall from Algonquin in 1996 was followed by Rexall’s acquisition of Pharma Plus chain for $100 million and Rexall kept growing until Katz sold the unit to McKesson in 2016. McKesson paid $3 billion for Rexalls’ 460 drug stores, or about $6 million for each store.
Neighbourly’s 275 drugs stores are probably worth somewhere around $4-5 million per store (since they are smaller community stores and stores in clinics) but that puts a rough value on the chain of $1.4 billion today ($1.1 billion when adjusted for debt) or $25 a share, not that far from the $20 a share the market values NBLY shares at today.
Likely owing to nostalgia, I like the drug store business and think the prospect of steady profitable growth makes NBLY worth a spot in my portfolio so I have opened a position with 1,000 shares. If the coming recession triggers a sell-off, I will add at that time.