An admirable performer, but no need to rush in

In a retail sector that has delivered more than its fair share of success stories, few can rival that of Clicks. It is a success story built on a rock-solid cash-only drug store model generating earnings and dividend growth in good and bad times.

“A combination of health care and beauty is one of the most sustainable business models,” says Clicks CE David Kneale.

Spearheaded by 473 Clicks stores and 346 in-store pharmacies, the model is also hugely profitable, producing a return on equity (ROE) of 55%-60% with clockwork consistency. Averaging 57,4% over the past two reporting periods, Clicks’ ROE is the highest of any listed retailer.

Its strategy remains very much expansionary in SA. “There is still a lot of scope for us to expand [here],” says Kneale. “We are investing a record R379m this year [to August] and will end it with 488 Clicks stores. Our longer-term target for stores in SA is 600.”

In the drug store realm Clicks has one notable challenger: Dis-Chem, which is tipped by sector analysts to list this year.

Independent retail analyst Syd Vianello believes that excluding Clicks’ UPD pharmaceutical distribution business, Dis-Chem could rival Clicks on turnover — about R14bn annually. Dis-Chem has a focus on Gauteng, where 48 of its 84 stores are, and Vianello says it is also “expanding aggressively.”

But Stanlib retail analyst Theresa Heath does not see Dis-Chem as a major threat to Clicks. “Dis-Chem has very large destination stores while Clicks stores are mostly smaller and provide an important niche convenience service,” says Heath.

Whatever the Dis-Chem factor may be, Clicks has continued to perform admirably under tough market conditions. Reflecting this, in the six months to February 2015 the Clicks stores division upped sales 10,5% year on year to R6,7bn, and sales volume adjusted for 3,9% product price inflation by a solid 6,6%. Like-for-like store sales lifted 7,6%. “Clicks continues to gain market share,” says Kneale. In Clicks’ key front-shop health, skincare and haircare segments market shares in the six months to February stood at 28,9%, 26,2% and 25%, respectively, while in the pharmacy sector it held an 18,5% share.

The ability of Clicks’ business model to excel does not end at the store level. The company is also hugely cash generative.

With cash generation way above expansion and working capital requirements Clicks has long pursued a policy of returning excess cash to shareholders. Share buybacks have been a key feature of this, totalling R1,62bn since 2010. Put in perspective, this exceeded Clicks’ shareholders’ funds of R1,57bn at the end of its latest interim reporting period.

Scope for further buybacks appears limited by share marketability considerations. The alternative is reducing dividend cover. It is an approach that seems to be under way, Clicks indicating that its dividend cover in the year to August 2015 will be 1,7 times headline EPS (HEPS), down from 1,8 times in the past three financial years.

Though further dividend cuts appear probable, Kneale gives nothing away beyond saying: “The cut sends the market a signal that we are confident of our ability to grow the business.”

Clicks is undeniably a blue-chip company with outstanding management. However, quality and value should never be confused. The big question is: do Clicks’ immediate growth prospects justify its current super-premium 25,6 price-earnings rating?

On Clicks’ guidance, HEPS will rise 10%-15% in its year to August, a pace not dissimilar to the average 10,6%/year over the previous three years. Good, given tough market conditions, but it leaves Clicks looking expensive compared with its mean PE of 17,4 over the past 10 years.

For patient long-standing shareholders Clicks rates a hold. For would-be investors there appears to be little urgency to rush in and buy.