In April 2003 Clicks Group Ltd bottomed at under R5.50 per share. It had become a company that even some deep-value investors no longer wanted to touch.
Its offering was stale and its unique proposition unclear. As the head of equities at Sanlam Investment Management, Patrice Rassou, notes, the market largely saw it as a fallen angel.
“Everyone acknowledged that the pharmacy was a good business, but no one could see much money being made from front of house,” Rassou says. “What was so special about their footprint if they were just selling toys and whatnot? If shoppers could get these products from a food retailer, why would they go to Clicks?”
Over the last decade and a half, however, the company has defied this pessimism. Since David Kneale took over as CEO in 2006, the share price has appreciated around 2 500%. It has been one of the JSE’s most reliable performers over this time, particularly the last five years when the overall market has moved sideways.
“What they changed is that they created a whole experience,” says Rassou. “The loyalty card has helped a lot, creating a very resilient customer that comes in year in and year out, and they have been ahead of the curve with their private label. They have been very targeted, making use of big data, which everyone does now, but they were already doing it 10 years ago.”
Reforming the market
Clicks’s biggest success, perhaps, has been reshaping the South African pharmacy market in its own image. The company has built the largest pharmacy chain in the country, and successfully managed the backward integration of its logistics and wholesale operations.
“They executed on this strategy extremely well,” says Rassou. “One of the reasons that Clicks has so many foreign shareholders is that they had seen this movie in their own markets, with Walgreens in the US or Boots in the UK. They have been willing to pay a premium, while for South African investors this might have been more difficult to foresee.”
Clicks’s strategy of growing its pharmacy footprint has been clearly articulated and well-executed. As Philip Short, an analyst at Old Mutual Equities points out, it took advantage of a highly fragmented market.
“It’s been a completely open market for them to take share,” says Short. “So you can see a clear line of growth. It’s steady, and not that expensive to do.”
All in the timing
The company was also either fortunate or prescient in that this consolidation took place at a time when consumer behaviour was undergoing a significant change.
“Pharmacies are not the only industry where we’ve seen this,” says Hannes van den Berg, co-portfolio manager of the Investec Equity Fund. “I struggle to find butchers these days because butchers have moved into supermarkets. It has also happened in liquor and various other markets. The businesses that have benefited from this consolidation have done well.”
What has made Clicks particularly successful, however, is the defensive nature of its offering. This is obvious in the case of pharmaceuticals, which people will need regardless of the state of the economy. However, many analysts have been surprised by how its health and beauty proposition has defied tough business environments.
“The market has been surprised at how defensive beauty has been as a category,” Rassou says. “The mindset that beauty was discretionary was turned on its head after the financial crisis. People are cutting back on a lot of things but not their beauty products. Even people feeling down in the dumps want to look good.”
Samantha Hartard, co-portfolio manager of the Discovery Balanced Fund at Investec Asset Management, agrees.
“Over the last 10 years Clicks has delivered a very consistent earnings growth profile,” she points out. “It’s become such a reliable share as it generates these earnings off the back of not just the pharmacies, but also personal care, which has proved to be quite defensive. It’s this reliability that the market has liked.”
One of the most remarkable things about Clicks is the competitive advantages it has created for itself. It has come to dominate the retail pharmacy sector and grown like-for-like sales faster than any other listed retailer over the past five years.
Hlelo Giyose, chief investment officer at First Avenue Investment Management, says this is because the company has not just one but three distinct moats.
“The first is a cost-advantage moat driven by significant scale resulting in 30% lower pricing than independent pharmacies,” he says. “The second moat is a rational oligopoly with Dis-Chem, resulting in these two players consistently gaining share from the independent pharmacies to own almost half the market now. The third moat, intangible assets, comes from having one of the largest and most profitable loyalty cards, which creates recurring revenue through customer retention, and increases basket size to double the spend of non-card customers.
“All this, coupled with stellar capital allocation towards consistently high dividend growth and share buybacks, makes this a low risk, steady compounder of both fundamental and market returns,” Giyose adds.
After 13 years in charge, Kneale stepped down as CEO at the start of 2019 – however Hartard believes there is good reason to believe that Clicks will continue to deliver.
“Clicks has a highly rated management team, and it’s demonstrated how stable leadership and good succession planning is key for any company,” she says. “We don’t see it often enough with South African companies. There might be a lot of focus on Kneale stepping down, but Vikesh Ramsunder, who takes over, has been COO for the last three years and has been in the business since 1993. That sort of planning gives comfort to the market as well. We are not going to have a new personality coming in and trying to change the business model.”