The tougher things get for Jean Coutu Group Inc., the more it makes sense for the Quebec-based drugstore chain to find a partner – and things are definitely getting tougher.
The latest challenge comes from the Quebec government, which announced that it will slash its spending on generic drugs by about 35 per cent, saving the government $1.5-billion over five years.
Jean Coutu, whose Quebec stores account for more than 90 per cent of its network, owns a generic drug manufacturer, Pro Doc, which is going to get hurt by these government cutbacks.
Mark Petrie, an analyst at CIBC World Markets, slashed his operating profit forecast for the drug manufacturing division in fiscal 2019 by 51 per cent.
This of course weighs on his profit forecast for the parent company. Mr. Petrie had previously estimated that Jean Coutu could generate a profit of $1.22 a share in 2019. Now, he's cut that to $1.11 a share, a 9-per-cent haircut and lower than Jean Coutu's reported profit in fiscal 2016.
This latest challenge to Jean Coutu's profit comes at a time when drugstores are struggling for growth in a mature market and rising competition from diversified retailers such as Wal-Mart Stores Inc.
Some drugstores have responded to these pressures by consolidating or accepting takeover offers. Most notably, Shoppers Drug Mart Corp. merged with Loblaw Cos. Ltd. in a $12.4-billion deal in 2013. Even so, growth remains slow at the combined company: Pharmacy same-store sales growth slowed to 2.9 per cent in 2016, down from 3.7-per-cent sales growth in 2015.
Jean Coutu has remained resolutely independent, confident that it can find growth opportunities on its own. The Coutu family, led by the now-90-year-old founder and current chairman, Jean Coutu, has shown no interest in selling. And what the family says goes: It controls the company through its multiple voting shares. But will the family change its mind?
The longer the company plods along, the more a deal makes sense. Its profit, on a per-share basis, has risen just 5 per cent – total – over the past five years. Revenue has been growing in the low single digits a year; it rose just 2.7 per cent in the first quarter, year over year. The Quebec government's regulatory reforms on generic drug payments, which kick in on Oct. 1, simply add to the argument in favour of a merger.
The grocer Metro Inc. remains the most likely partner. Loblaw showed that grocers can work well with drugstores, and Metro in particular would be a politically acceptable suitor given that it is based in Montreal. That is, the combined entity would remain Quebec-based. As well, Metro has shown that it can make big deals successfully: It purchased A&P Canada in 2005 for $1.7-billion.
The two companies have been linked in investors' imaginations before. Soon after the Loblaw-Shoppers Drug Mart deal was announced in 2013, Jean Coutu shares embarked upon a 65-per-cent rally over the next 18 months, to a high of $29, in anticipation of a similar deal.
But investors appear to have given up: The shares closed on Wednesday at $20.45. Observers are similarly unenthusiastic. According to Bloomberg, the 11 analysts following the stock have an average price target of $20.91, implying a 2-per-cent gain above the current price.
This is good news. It suggests that there isn't much optimism built into the share price, leaving some room for an enticing bid from a suitor. When Loblaw announced its deal for Shoppers Drug Mart, it paid a 29-per-cent premium.
Can Jean Coutu go it alone? Yes. It is streamlining operations with a new distribution warehouse, expanding its online presence and, hey, there are marijuana sales to contemplate.
Staying independent could reward investors in other ways, too. Mr. Petrie noted that Quebec's regulatory reforms, while a drag on profit, remove some uncertainty that had been hanging over the stock. That could mean the company will increase share buybacks, announce dividend hikes or issue special dividends.
In other words, patient investors will be rewarded, even as they await a deal that makes more sense than ever.