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A consumer goods stock with growing dividends

Jean Coutu Group’s earnings are rising very slowly. But with lots of cash and excess cash flow, this debt-free consumer goods stock can afford to continue paying rising dividends. It remains a buy for decent and growing dividends as well as long-term share price gains.

We regularly review Greater Montreal-based Jean Coutu Group (TSX─PJC.A). Since mid-September, its shares have slipped by 4.6 per cent. The company did a little better in the nine months to November 28, 2015. More important, Coutu’s excellent balance sheet and excess cash flow gives it the means to reward you and build its business. The shares remain a buy for decent and growing dividends as well as long-term capital gains.

At first glance, Coutu’s performance looks disappointing. In the first nine months it reported a net profit of $162.2 million, or 87 cents a share. This was unchanged from a reported net profit of $163.7 million, or 87 cents a share, a year earlier. But this was entirely due to an adverse tax ruling.

In the first nine months, Coutu’s revenue rose by 2.3 per cent, to $2.148 billion. This reflected three factors. One is a 1.6 per cent increase in its selling per square footage. Second is a 1.9 per cent rise in same-store sales which is a critical statistic for retailers. And third were the higher sales by wholly-owned generic drug maker Pro Doc.

Two factors slowed its revenue growth

Coutu’s revenue growth, however, was slowed by two negative factors. First, prescriptions of lower-cost generic drugs are displacing prescriptions of higher-priced brand name drugs. In the third quarter, generic drugs accounted for 69.6 per cent of all prescriptions—up from 68.1 per cent a year earlier. The second factor was price reductions on generic drugs imposed by the Quebec government.

Coutu’s cost of sales rose by 2.6 per cent—more than sales. The drop in the loonie likely raised the prices of imported goods. Coutu did a good job of controlling its other costs. All regular costs went up by 2.3 per cent—the same as sales.

Coutu’s pre-tax income rose by two per cent, to $229.1 million. The trouble is, the Quebec Court of Appeal overruled a lower-court judgment and forced the firm to add $4.7 million to its tax bill. The Supreme Court of Canada will hear the case in May.

In the first nine months, Coutu’s cash flow inched up by 1.8 per cent, to $255.2 million. This confirms its slightly higher profits—excluding possible extra income taxes. The cash flow exceeds net capital investment of $88.3 million and dividend payments of $61.7 million. The company generated excess cash flow of $105.2 million.

Coutu has no debt and cash of $122.1 million. This and its excess cash flow will enable this ‘dividend aristocrat’ to continue to raise dividends each year. It will also assist the company in continuing to expand its business and renovate its stores.

Coutu’s profits are expected to grow slowly. In fiscal 2016, it’s expected to earn $1.18 a share. This is up little from $1.16 a share last year. In fiscal 2017, which start in March, the company’s earnings are expected to rise marginally, to $1.19 a share. Based on this earnings estimate, the shares trade at a forward price-to-earnings ratio of 16.5 times. That seems somewhat high for a company facing government pressure.

Is more government intervention the future?

The baby-boomers are aging. As they do, they’ll need more prescription drugs. But cash-strapped provinces will seek to cut the enormous costs of health care, including drugs.

Jean Coutu Group faces pressure from the dirigiste (interventionist) Quebec government. President and chief executive officer François Coutu refers to “the restrictive regulatory context which prevails in our industry”. Quebec imposes ‘periodic deductions’ that cost pharmacists money. It also plans to remove the 15 per cent cap on professional allowances.

Alberta, B.C. and Ontario have younger populations than Quebec. But as their populations age, these provinces may become more interventionist too. That could limit the profitability of drug-store chains such as Jean Coutu.

 

The Investment Reporter [1], MPL Communications Inc.
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