After the Ontario government announced that it will cut back prices of generic drugs, hammering the shares of Shoppers Drug Mart Corp. SC-T in the process, one of the more severe reactions came from Desjardins Securities’ analyst Keith Howlett.
As we noted earlier, Mr. Howlett cut his recommendation on Shoppers to “sell” from “hold” and reduced his target price to $39 from $50. Here’s some of the thinking behind the move.
He estimated that Ontario’s actions could reduce Shoppers’ annual earnings by 40 to 60 cents a share. As a result, his new target price reflects a price-to-earnings ratio of 14, based on estimated 2010 earnings of $2.80 a share. His previous target used a P/E of 17, based on estimated 2010 earnings of $2.92 a share.
“It is as yet unclear when the proposed measures will take effect,” he said in a note released early on Thursday morning. “We are withdrawing our 2011 forecast until we have greater clarity on how other provinces react to the Ontario government actions, and learn the response of private third-party payers.”
He is also concerned that other provinces could follow Ontario’s lead, as they, too, try to shave their health care costs.
“While both Alberta and Québec have recently redesigned their own generic drug reimbursement frameworks, they may now revisit them,” he said.
However, Mr. Howlett hints that there could be a longer-term opportunity here. That’s because lower profitability among drug stores could encourage more consolidation in the sector.
“Shoppers Drug Mart will be the primary beneficiary. The cost of buying pharmacists’ script files will decline substantially,” Mr. Howlett said.
“It is possible that regulatory changes in Ontario could create an opening for Jean Coutu Group (PJC) Inc. PJC.A-T to expand further outside of Quebec, should, for example, co-operative banner chains such as Pharmasave begin to falter and need to redefine their consumer proposition.”
