Net income dips at SDM despite robust front end.(Business)

TORONTO -- With prior-year results propped up by a onetime gain, Shoppers Drug Mart (SDM) saw first quarter net income slip 3.9% on a 2.7% sales gain. However, earnings--which met analysts' expectations--rose over adjusted prior-year results.

Net income for the 12 weeks ended March 26 fell to $117.5 million (Canadian), or 54 cents per diluted share, from $122.3 million, or 56 cents per share, in the 2010 quarter, when the company booked a $12 million pretax gain on a sale/leaseback transaction. Backing out that item, earnings increased by 3.4% over 2010's adjusted figure of $114 million.

Sales reached $2.35 billion, up from $2.28 billion. Results missed the $2.38 billion average estimate of analysts polled by Thomson Reuters, as the chain's prescription business continued to be squeezed by recently implemented drug system reform initiatives in certain provinces--principally Ontario, British Columbia, Alberta and Quebec--as well as the effects of higher rates of generic drug utilization. The difficulties in the pharmacy were countered by strong front-end sales growth in all regions of the country.

Chainwide, pharmacy sales receded 0.4% to $1.15 billion, or 49% of revenues, down from a 50.6% share a year ago. Front-end business, meanwhile, vaulted 6% to $1.20 billion.

On a same-store basis, sales were up 2%, as a solid 4.4% gain at the front end was diluted by a 0.4% decline in pharmacy. Management notes that continued growth in prescription volume was offset by a reduction in the value of the average prescription--due largely to lower generics reimbursement rates. Prescription counts advanced 3.9% chainwide and by 3.7% on a same-store basis. All told, generics accounted for 56.6% of prescriptions filled, up from 53.2% a year ago.

It was a far different stow at the front end, where management notes that "effective marketing campaigns, differentiated and impactful promotions, and solid program execution at store level drove sales growth and market share gains in the company's core health, beauty and convenience categories."

During a conference call chief financial officer Brad Lukow told analysts that a growing proportion of front-end sales were coming from promotions, thereby crimping margins.

Still, gross margin for the quarter improved 25 basis points to 37.8%. But this was countered by an 89-basis-point jump in operating and administrative (O&A) expenses (including amortization and the aforementioned prior-year gain) to 30.22% of sales. With that, operating income decreased 5.3% to $177.9 million.

Commenting on the decline in operating income, management stated that "benefits realized from further gains in productivity and efficiency were partially offset by increased amortization and higher operating expenses at the store level associated with the company's network growth and expansion initiatives, and by continued investments in pricing and promotional activities."

After factoring in a 5.5% increase in interest expense to $14.6 million, pretax income dropped 6.2% to $163.3 million. This was countered somewhat at the bottom line by a lower effective tax rate in the 2011 quarter.

"We are pleased with our performance in the first quarter of 2011," David Williams, director and interim president and chief executive officer, said in a statement. "This is a particularly solid result, considering that we are in the midst of working through a difficult period of transition as we adjust our business and service model in response to government reform initiatives and the resultant funding and reimbursement pressures on our pharmacy business."

During the quarter 18 drug stores were opened or acquired (including 11 relocations), while three smaller units were closed. The chain also completed four major drug store expansions, while 12 established locations were remodeled to smaller prototype formats.

At quarter's end the network had a total of 1,316 stores, including 1,245 drug stores (1,185 Shoppers Drug Mart/Pharmaprix stores and 60 Shoppers Simply Pharmacy/Pharmaprix Simplement Sante stores), 63 Shoppers Home Health Care stores, and eight Murale stores.

                            Current   Previous                             close     close       Net       %Chain drug stocks           5/9/11    4/18/11    change    changeDow Jones Composite         4366.93   4179.39    +187.54    +4.49  AverageCVS Caremark                  37.48     33.89      +3.59   +10.59Rite Aid                       1.15      1.05      +0.10    +9.52Walgreens                     43.10     39.64      +3.46    +8.73                            52-week   52-week                   P/EChain drug stocks            high       low     Div.   Yield   ratioDow Jones Composite         4438.86   826.97  AverageCVS Caremark                  37.64    26.84    0.50    1.4     15Rite Aid                       1.47     0.86     --     --      --Walgreens                     47.11    26.26    0.70    1.7     18                            Current   Previous                             close     close       Net       %Canadian drug stocks *      5/9/11    4/18/11    change    changeJean Coutu Group             10.99     10.17      +0.82    +8.06Shoppers Drug Mart           41.37     40.25      +1.12    +2.78                            52-week   52-week                   P/ECanadian drug stocks *       high       low     Div.   Yield   ratioJean Coutu Group             11.10      7.88    0.24    2.2     14Shoppers Drug Mart           41.96     32.57    1.00    2.4     15* Figures are in Canadian dollars.                            Current   Previous                             close     close       Net       %Internet drug stores        5/9/11    4/18/11    change    changedrugstore.com                3.78       3.89      -0.11    -2.83                            52-week   52-week                   P/EInternet drug stores         high       low     Div.   Yield   ratiodrugstore.com                3.94      1.48      --     --      --                            Current   PreviousParent companies &           close     close       Net       %      5combo operators             5/9/11    4/18/11    change    changeAhold (combos)               13.74     13.27      +0.47     +3.54AmerisourceBergen (GNP)      42.22     39.29      +2.93     +7.46Cardinal Health (Medicine    45.30     41.32      +3.98     +9.63  Shoppe)Kroger (combos)              24.29     23.70      +0.59     +2.49McKesson (Health Mart)       84.74     79.59      +5.15     +6.47Supervalu (combos)           10.50      8.84      +1.66    +18.78Parent companies &          52-week   52-week                   P/Ecombo operators              high       low     Div.   Yield   ratioAhold (combos)               14.27     12.05     --     --      14AmerisourceBergen (GNP)      42.50     27.09    0.40    1.0     18Cardinal Health (Medicine    45.49     29.69    0.86    1.9     16  Shoppe)Kroger (combos)              24.93     19.08    0.42    1.7     14McKesson (Health Mart)       84.99     57.81    0.72    0.9     19Supervalu (combos)           14.24      7.06    0.35    3.3     --                            Current   PreviousOther retailers              close     close       Net       %                            5/9/11    4/18/11    change    changeSears (Kmart)                77.00     79.83      -2.83    -3.55Target                       50.00     49.95      +0.05    +0.10Walmart                      55.10     52.35      +2.75    +5.25Other retailers             52-week   52-week                   P/E                             high       low     Div.   Yield   ratioSears (Kmart)               115.45     59.21     --     --      66Target                       60.97     48.23    1.00    2.0     13Walmart                      57.90     47.77    1.46    2.7     12