Dis-Chem is due to list on the JSE on 18 November 2016. While the group was founded in 1978 by the Saltzman family with their first pharmacy opening, its growth profile has taken off in recent years with the store base tripling since 2008 (28 stores). The group has ambitious growth plans yet, with identified opportunities for doubling the store base over the next 5-8 years. Despite Dis-Chem’s comparatively smaller store base (100 vs Clicks’ 500), the

group’s retail market share is similar to Clicks (which has smaller stores). We expect further market share gains in the years ahead, driven by maturation of existing stores (1/3 are not yet mature) as well as a robust new-store pipeline. Our key gripe with the business is its inferior cash-flow generation compared to Clicks, but further scale could possibly resolve this issue.

Dis-Chem plans to list at a price range of R16.25-R20.25/share. This implies a equity market value of R15.7bn at the mid-point of the range post listing, equating to a trailing EV/EBITDA multiple of 15.5x (12-month EBITDA to August 2016). Under the new capital structure (detailed below), we estimate the group is likely to earn 70cps of HEPS to February 2017, placing the stock on a 26x P/E to FY17 on the basis of the mid-point of the offer range. It is important to note, however, that the final placement price may be outside of this range – if this is the case, we believe it is likely to be above the guided range due to what is a well anticipated and sought-after new listing.

The group is offering 238.4m shares in the listing (27.5% of the total issued share capital at listing), raising R4.325bn in the process (the mid-point of the valuation range). This is to

be deployed as follows:

 R700m will be utilised to reduce debt (currently approximately R2.2bn).

 Acquisitions of CJ Group and minority interests in 9 partner pharmacies – R460m.

 A share repurchase totaling R3.575bn from existing shareholders prior to listing in order to achieve the required free-float of 28.3% on listing. Post-listing and repurchase, the Saltzman family will own 53% of the equity.

We believe Dis-Chem is poised to sustain strong growth in earnings in the coming years.

 Not all existing stores have reached maturity (one-third of existing stores have been open for less than four years), so same-store sales should remain strong, driving margin

leverage on existing stores.

 The group is planning to open 100 stores over the next 5-8 years, and the return on capital on new stores is exceptional. A typical store should cost R20m (capex+initial working capital) and contribute ~R12m in EBIT within four years (>60% ROCE), with break-even coming within one year. To put this into perspective, this means that each year the group is adding an extra 15%-20% (R100m+ PAT) to group profit potential at store maturity from new openings alone. So, while new stores might initially lose money, the group also has previously new stores maturing every year (hence those losses are falling out of the base).

 The group already generates a 53% return on equity and given the rate of investment into new stores and a dividend policy of 40% payout, we expect earnings on a trend basis to grow by 25% per annum. This is provided that store-targets and trading densities are achieved.

Dis-Chem is clearly an exceptional business that has a unique opportunity to grow aggressively through a store roll-out plan that will see it gaining further share from independent pharmacy chains, and likely from Clicks too. The valuation is rich at a 12-month forward 22x P/E multiple (26x to Feb ’17), but if growth plans come to fruition, investors could still do well from this initial heady valuation level. Assuming pricing at the mid-point of the guided range, we prefer Dis-Chem to Clicks and would advocate a switch. We do, however, caution that demand is likely to be high and investors are unlikely to receive their full (or even partial) allocation.