Dischem: Losing the small store war

Size matters, especially if you’re Dis-Chem.

With a product range of more than 60,000 and too many square metres to fit into small-town malls, Dis-Chem — supposedly the fast-growing upstart to established incumbent Clicks — is battling to compete.

In this cash-constrained environment, Clicks’s essentials product lines are more appealing to customers than Dis-Chem’s huge ranges, analysts say.

But the company has hit back at criticism, saying it can "do small" and is financially on a good footing to generate returns, even after releasing a disappointing set of interim results last week.

Dis-Chem posted a 38.9% fall in headline EPS, to 31c, notwithstanding a 13.2% rise in group revenue, to R11.8bn.

Much of the fall was due to one-off costs — such as a 20% jump in financing costs after Dis-Chem bought more stock to mitigate the effects of a strike earlier this year.

CFO Rui Morais says: "Stockpiling was essential to ensure availability and not compromise sales to customers."

But the reduction in purchasing led to lost revenue. That’s because the retail pharmacy earns advertising revenue and fees from selling customer data to suppliers, but those fees are worked out as a percentage of purchases, which fell as a result of the industrial action.

Dis-Chem’s labour issues — strikes during two consecutive financial years — have clearly left a scar on the company, and co-founder and CEO Ivan Saltzman stressed at an investor presentation that Dis-Chem has been "rebuilding relationships" with employees.

For example, they have now been given a primary care medical plan to pay for non-hospital events.

"Increased morale and productivity shows we are moving in the right direction," says Morais.

The bigger problem for analysts is that Dis-Chem’s one-off costs seem to be a perennial feature of its results since listing on the JSE in November 2016.

Sentio Capital executive director Imtiaz Suliman says: "The big disappointment with inconsistency of delivery with their earnings is that there have been one-offs occurring every few years."

And if you strip out those one-offs, Dis-Chem is not performing as well as its market rating would suggest, notwithstanding this year’s 15% fall on the JSE.

"If you take off one-off costs, profit before tax is 5.5% down," admits Morais.

Yet Dis-Chem trades on a forward p:e of 28.2.

A higher ratio is generally a sign that a company is able to generate higher profits — and therefore warrants a high rating — but in Dis-Chem’s case this is not yet happening.

Clicks, meanwhile, trades on a forward p:e of 33, but it grew headline earnings 16.8% in the year to end-August.

While Dis-Chem continues to open stores — 20 in the period under review, taking its total to 158 at end-August — the company has yet to master expansion to smaller areas with smaller store formats, despite promising to do so when it listed.

Electus fund manager Damon Buss says: "Dis-Chem’s key competitive advantage is their range, which they can’t fit into smaller stores. They have not convinced us that they can make small stores work as well as the big-box format."

Buss is also concerned that some of the new Dis-Chem stores are cannibalising the company’s own market share.

"In the Greenstone node, they’ve opened two new stores since the 2016 financial year, yet the combined earnings before interest, tax, depreciation and amortisation in FY2019 of the three stores is only R700,000 — 2.8% higher than the initial Greenstone store delivered in 2016," he says.

Suliman is more positive and says some of the difficulties with smaller stores are simply teething problems.

Morais, obviously, agrees: "Smaller is nothing we can’t do."

But, he says: "Our strategic driver has been where space presents itself."

As fewer malls are developed, Morais says Dis-Chem "will go into more residential-type nodes". He adds that it’s not true that small stores drive convenience. "Location drives convenience."

Dis-Chem is also betting on its push into telemedicine to attract customers to its clinics.

This allows nurses to dial up to a doctor over video who helps and prescribes medicine to the patient.

Telemedicine is part of the "synergistic strategy" — attracting pharmacy patients who leave with a basket of other goods.

Morais is convinced that the insurance market will drive people to the telemedicine model, and Discovery Health has confirmed it has committed to funding pharmacy-based care and telemedicine from 2020.

In the past financial year, Dis-Chem also bought 50% of Health Window for R16m.

It is a chronic medicine adherence provider, tracking when people have not filled out scripts and messaging them reminders.

Better adherence means increased revenue spent on scripts, even as spend per patient falls as more switch to generics.

Morais says analysts are missing a trick on the company’s telemedicine strategy as retail analysts don’t "do justice to health care" and don’t understand it.

But Sasfin Securities retail analyst Alec Abraham is not convinced: "Telemedicine and the importance of in-store clinics for primary treatment may be more important to manage health-care costs … but I believe expanding the store network is the immediate imperative."