Neighbourly Pharmacy (NBLY) chain, Canada’s third-largest pharmacy chain operator, has filed preliminary documents for a $150 million initial public offering (IPO) on the TSX. Founded in 2015, NBLY (also formerly known as Rx Drug Mart) has grown to 145 locations across Canada. Shares are expected to list during the week of May 24 with a share price between $13 and $17.

NBLY is owned and controlled by Persistence Capital Partners, a private equity fund exclusively focused on high-growth opportunities in the healthcare field. Armed with deep healthcare industry expertise, PCP aims to create a significant long-term capital appreciation for its investors by identifying attractive investment opportunities in the Canadian healthcare market. Some of its current investments include Summit Veterinary Pharmacy, Anova Fertility & Reproductive Health, and Medspa Partners. PCP has previously sold some of its investments to Telus Corp (Medisys Health Group), Eurofins (EnvironeX Group), and Gamma-Dynacare of LabCorp (Lab-Biomedic).

Business Model

NBLY is Canada’s largest and fastest-growing network of community pharmacies. With 145 locations, NBLY is the third-largest national pharmacy operator and is estimated to own one percent of all Canadian drugstores. This is just behind Rexall and Shoppers Drug Mart, which collectively own 16 percent.

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Nearly two-thirds of NBLY’s pharmacies are in communities with populations of fewer than 100,000, and over 75% of revenue is earned from sales of prescription medication, rather than “front shop” items such as cosmetics, food items, and such.

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Focused on smaller, underserved communities, NBLY’s pharmacies strive on offering accessible healthcare in such areas with a personal touch and less intense competition. As such, the pharmacies are able to provide a broader range of services to patients, while generating higher margins than in dense, urban centers where there is more competition.

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NBLY’s adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) have improved steadily over the past few years, with margins seeing some fluctuations. NBLY has been able to improve its operating leverage over the years with the use of a common corporate structure and platform and optimizing merchandising, inventory, and labor resulting in decreasing corporate costs as a percentage of revenue. With the backdrop of 70 locations acquired over the last two fiscal years, in 2019, NBLY posted adjusted EBITDA of $14.4 million on revenue of $150 million, while in 2020, it achieved adj. EBITDA of $21.2 million on revenue of $186 million.

Industry Tailwinds and Organic Improvement

Retail pharmacy is a highly regulated, payer-driven industry, which is stable, resilient, and growing. While Canadian pharmacies’ regulations are determined by their province or territory, public and private payers drive reimbursement, which is largely standardized. This adds a utility-like twist to this pure-play business. Additionally, retail pharmacies are playing a critical role in vaccinating Canadians against COVID-19 resulting in higher foot traffic and organic sales growth in pharmacies.

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NBLY continues to add new clinical services capitalizing on pharmacists’ expanding scope of practice, which in underserved areas would reflect directly in top-line and bottom-line figures. Management expects an increase in prescription count in line with industry expectations as Canada’s aging population increases. As per Statistics Canada, the Canadian population aged 65 or over is expected to increase by 50% from 2020 to 2035, making this the right time for NBLY to access more liquidity to support growth.

Pro-Forma Capital Structure and Valuation

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The majority of the net proceeds of the IPO of $150 million will be used to repay indebtedness. Management expects to have approximately $90.3 million in net debt outstanding after the IPO, and upon closing, will receive $250 million in credit facilities from a syndicate of lenders. Future acquisitions are expected to be funded through a combination of free cash flow, cash on hand, and additional indebtedness. Management also quantified that the acquisition program is expected to be fully funded for the next 18 to 24 months, $53 million of cash and $150 million of undrawn revolver capacity post-IPO, as low maintenance CAPEX requirements drive significant free cash flow conversion for the business.

EV = Market Cap + Net Debt (Debt – Cash)

= $150 + 90 = $240

EV/EBITDA (LTM) = $240/$21.2 = 11.3x

Looking at valuations, using very conservative numbers, we come to an EBITDA multiple of 11.3x for NBLY with the current market cap (IPO), net debt, and LTM (Last twelve months) EBITDA figures. For reference, Walmart trades at 11x EBITDA, and Loblaws stands at 8.5x. We think NBLY’s 11.3x is fairly priced given that it is a one-of-a-kind pure-play pharmacy that will be public soon, and margins for the business tend to be better than other segments.

Prior Acquisitions in the business

Rexall is one of the major rival pharmacies in Canada to NBLY and Shoppers Drug Mart (owned by Loblaws). With over 470 locations, Rexall comes in second-largest pharmacy company in Canada, just behind Shoppers. While there are no recent transactions in this space, in December 2016, McKesson Canada Corporation purchased Rexall for $3 billion from Katz Group of Companies. In 2016, National Bank Financial estimated Rexall to have annual sales of $2 billion to $2.5 billion generating annual EBITDA of roughly $200 to $250 million. Using the estimates of the numbers, the (private) EBITDA multiple comes in between 12-15x for Rexall, which makes NBLY’s numbers fairly conservative.

Financial History

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Conclusion

NBLY offers investors a one-of-the-kind pure-play Canadian pharmacy opportunity. NBLY’s acquisition model has supported the company to develop a network of 145 stores across 27 transactions since 2015. While acquisitions have been a significant driver of NBLY’s growth, the company has also demonstrated compelling organic improvement. NBLY’s three growth pillars, namely acquisitions, organic improvement, and external tailwinds, stand to support its trajectory. Management extensive experience in retail pharmacy, mergers, and acquisitions, and consumer retail speaks volumes and makes us more comfortable. Lastly, the valuations presented, and forecasts seem very reasonable to us even without pricing in the growth prospects. We will be watching this one closely.

Happy Investing!

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Disclosure: Authors, directors, partners and/or officers of 5i Research or related companies do not have a financial or other interest in NBLY at the time of publishing