Tuesday, August 25, 2009

China Nepstar Chain Drugstore (NYSE:NPD): Cut to Sell with $4 target at Roth

Roth Capital Partners is downgrading shares of China Nepstar Chain Drugstore (NYSE:NPD) to Sell with $4 target following quarterly results and special dividend announcement yesterday:

Trimming revenue est following another quarterly miss. NPD 2Q09$78.2mm revenue missed estimated $86.2mm for the 2ndconsecutivequarterly miss, attributed to 1) Drug retail sales slowdown amid unfavorablemacroeconomic conditions which struck hardest in Guangdong and YangtzeRiver Delta, where most of Nepstar's stores are located, 2) Exclusion of salesfrom 355 Yunnan JZJ drug stores previously included in 2008 revenue. Welower our 2009 forecast to $327.5mm (-6% yoy) from previous $351.4mm(0% yoy). We forecast 15% 2010 sales growth, down from previous 20%, to$376.6mm revenue for lack of near-term drivers for drug retail business andthe meaningful-sized M&A and store openings (on average, ~400 storescontribute to $0.01/ADS annual earnings).

Gross margin compression expected as EDL impacts roll in. We forecastgross margin decrease due to the change in competitive landscape forNepstar from the price regulation in hospitals' pharmacies by the health carereform zero premium policy. While Nepstar caters to middle/upper middleclass consumers who are less dependent on pricing stipulation, we anticipate1-2 pts of gross margin compression in combination with a relatively rigidopex >40%. The diversification of the portfolio into high margin,nutraceuticals and non-pharmaceutical products may partially buffer thisimpact.

Special dividend. As we applaud mgt's decision in returning cash($1.50/ADS before year end) back to the investors, we believe it acquiescesthe challenges to generate favorable return on capital, at least near/mid term.

Downgrade to Sell rating, Maintain $4 PT. While we highly regard mgt'sefforts in making sound decisions in store closings, cost cutting, M&A anddividend paying, we see slow recovery in drug retail business in both macroand micro aspects. Our comparable analysis assigns 13x multiple to Nepstarthat values the business at $2.10/ADS based on 2010 earnings. Adding$1.90/ADS forward cash to reach our $4.00/ADS price target.


Morgan Stanley is also commenting:

Cutting 09 sales further by 10% and EPS by 29%: NPD just reported 2Q09 results with revenue and EPS missing our estimates. Investors may respond positively to the special dividend of $1.5/share, but this is also a reflection of the difficulty in identifying good store acquisition targets. Given the 2Q09 miss and slow export recovery, we believe business is unlikely to rebound strongly in 2H09. We have reduced our sales forecast by 10% and EPS by 29%. However, we have raised our PT from US$5.3 to US$5.8 to reflect improved ROE. Although the new PT represents 20% downside from current levels, we are maintaining our EW rating on NPD shares due to the high volatility of the stock.

Action: After initial pop on special dividend and headline EPS number the stock gave back most of the gains yesterday. This downgrade makes sure that the rest of the gap is also erased. These comments make me wonder who the hell was buying it yesterday. Sure, special dividend is nice, but that's about all there is positive. Estimates are cut across the board and these aren't just some cosmetical corrections to make the DCF model look nice again.

Morgan Stanley has highlighted NPD as short-term short idea several times this year. Given their comments I would expect them to issue another short idea today or in the coming days. After all, their target is 20% below the current share price. Given the volatile nature of this stock staying at Equal-Weight makes sense, after all you cannot shuffle ratings back and forth all the time.. but short-term short recommendation would be suitable for those clients interested in trading idea. Of course, this is pure speculation on my part.

To sum it up: anything above $7 early today is short with covers starting at $6.8. Heck, it might do $6.6 today given the weakness in China today.

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