Wesfarmers: On a health kick

About the author:

Alex Lu
Author name:
By Alex Lu
Job title:
Analyst
Date posted:
13 July 2021, 9:30 AM
Sectors Covered:
Industrials

  • Wesfarmers (ASX:WES) has made a non-binding, indicative offer to acquire 100% of Australian Pharmaceutical Industries (ASX:API) for A$1.38 per share, valuing the company’s equity at A$687m (or EV of A$822m).
  • We estimate the offer represents an FY22F (Aug Y/E) EV/EBIT multiple of 10x, which looks reasonable given key competitors Sigma (Jan Y/E) and EBOS (Jun Y/E) are currently trading on ~14.5x and ~17x, respectively.
  • We think the health, well-being and beauty sector can provide long-term growth opportunities, but will require WES to invest in API’s supply chain, systems and product range to improve its competitiveness and operating efficiency.
  • We make no changes to earnings forecasts and retain our (login to view) target price. Hold rating maintained.

WES offers to acquire API for A$1.38 per share

Wesfarmers (ASX:WES) has made a non-binding, indicative offer to acquire 100% of Australian Pharmaceutical Industries (ASX:API) for A$1.38 per share, valuing the company’s equity at A$687m (or enterprise value of A$822m). 

API is an Australian distributor of pharmaceutical goods with a portfolio of wholesale and retail businesses in the health, well-being and beauty sector. API supplies and provides retail-support for Soul Pattinson and Pharmacist Advice and owns the Priceline and Clear Skincare retail brands.

The offer price represents a 21% premium to API’s last close price of A$1.145 per share and 22% to the one-month VWAP of A$1.133. We estimate the offer represents an FY22F (Aug Y/E) EV/EBIT multiple of 10x, which looks reasonable given key competitors Sigma (Jan Y/E) and EBOS (Jun Y/E) are currently trading on ~14.5x and ~17x, respectively.

API’s major shareholder Washington H. Soul Pattinson and Company (SOL), which owns 19.3% of the company, has agreed to vote in favour of the deal and has granted WES a call option in relation to its API shares.

The transaction is expected to be funded through existing balance sheet capacity, with WES having net cash of A$871m (ex-leases) as at 1H21.

The deal is conditional upon completion of confirmatory due diligence, entry into a Scheme Implementation Deed, obtaining ACCC clearance, and API board and shareholder approval.

Our view

We can see the rationale for WES entering the health, well-being and beauty sector given its attractive and defensive growth qualities over the long term. However, industry margins are low (FY20 EBIT margin: API 1.4%; EBOS 3.0%; and Sigma 0.9%) with API being negatively impacted by COVID-related retail store closures over the past 15 months.

If successful, WES will need to invest more in API’s supply chain, systems and product range to improve the company’s competitiveness and operating efficiency. We believe this is possible given WES’s strong retail and supply chain capabilities but is likely to take a number of years. 

We estimate the acquisition to be ~2% accretive to FY23 underlying EPS

Forecast changes and recommendation

We make no changes to earnings forecasts and retain our equally-blended (PE, SOTP, DCF) target price of (login to view) given the deal is subject to a number of conditions.

Hold rating maintained.

Price catalysts

FY21 result on 27 August.

Risks

Upside risks include better-than-expected performance by WES’s businesses and value accretive acquisitions. 

Downside risks include a slowdown in the housing market, failure of the retail businesses to adequately follow consumer trends, and inability of management to control costs. Disruptions due to COVID-19 remains an ongoing risk.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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