TSX Commentary

Shoppers Drug Mart Corp. (SC): $43.12 – A New Rx but Still Attractive Entry Point: Target to $52 From $56
Outperform, Average Risk, Price Target: $52.00 (prev. $56.00)
Investors have been apprehensive of Shoppers since early last summer when the Ontario government formally re-opened discussions around terms of its drug benefit program. While the initial target for resolution was late in Q3, the complexity of the issue combined with the emergence of a significant public health issue (H1N1) and changes at the Ministry have pushed the issue into apparent limbo – and SC’s share price along with it. Much ink has been devoted to quantifying the liability side of the proposed changes, but given the absence of details around potential offsets, there is little confidence in the output from any of these calculations. Shoppers’ share price performance and valuation suggest that investors are applying a discounted valuation multiple to 100% of SC’s earnings due to the perceived risk to earnings from Rx despite the ongoing 8% underlying annual unit growth count. RBC CM encourages investors to take a blended approach to SC’s valuation: apply a premium multiple of 1.2x the long-term sector average to the high-margin, highly successful front-of-store earnings, and a sector average multiple to the “at risk” earnings from Rx. Applying the valuation methodology outlined above and rolling forward to mid-2011 results in a reduction to RBC CM’s target price but the current share price represents an attractive entry point.