Dundee Securities has upgraded drug retailing, pointing to low historical valuation and higher industry margins.
“Owing to improved quarterly results and valuation metrics, we now believe that Canadian drug retailers such as Shoppers Drug Mart and Jean Coutu have become legitimate defensive candidates in the Canadian marketplace,” analyst Martin Roberge wrote in a report to clients.
The group has underperformed over the past several months even though the appetite for defensive stocks has revived, he noted.
That’ s despite regulatory uncertainties looming over the Ontario market
Industry margins have staged a strong rebound, thanks to a recovery in drug pricing and lower drug import costs resulting from a stronger Canadian dollar.
“We can see a positive correlation between relative industry margins, which recovered last year, and relative earnings-per-share strength,” he wrote.
“We can also see that much of the improvement in the industry net profit margin has come from Jean Coutu (from -45% in Q3/09 to -26% in Q4/09). Shoppers’ net profit margin has remained flat (5.9%).”
That might explain Coutu’s share price outperformance of Shoppers, he said.
As for valuation, the Canadian drug retailing index is trading at the bottom of its 10-year historical valuation range from the perspective of dividend yield (2%), price to cash flows (12.7 times), and price to earnings (18.4 time).
“Though these stocks offer less yield than other defensive stocks, we believe their cheap valuation metrics provide much downside protection for defensive investors,” he said.