CARING for 7-Eleven's Shareholders - Is Caring Pharmacy Worth USD 400M (RM 1.78B)?
How can a subsidiary company be worth >90% of its parent company's entire Market Cap (RM 1.9B)?
How is Caring Pharmacy worth in excess of 90% (RM 1.78B) of its parent company SEM’s entire market cap (RM 1.9B)?
In this report, we take a stab at estimating Caring Pharmacy’s fair value - and explore whether it is worth their apparent sticker price of USD 400M (RM 1.78B), as reported by Bloomberg.
We will also seek to understand how much incremental value their new RTE venture 7 Café can contribute to SEM’s existing valuation. (spoiler: quite a lot)
Note: There appears to be a discrepancy between SEM’s market cap as reported by Google (RM 1.9B) and on the Bloomberg Terminal (RM 1.75B). SEM’s own 1Q22 report reconciles with Bloomberg’s market cap figure - however, I shall be using the former market cap (RM 1.9B) in this report to be conservative.
In this recent Bloomberg article, it was reported that the parent company of 7-11 Malaysia (SEM) was weighing a sale of their subsidiary Caring Pharmacy (Caring) for USD 400M (RM 1.78B) - apparently to some interested Japanese parties. Prior to its delisting and subsequent acquisition by SEM in Oct 2020, Caring had reported an FY19 earnings of RM 38M. This would have implied an acquisition PE ratio of 46x for Caring. Naturally, this raised eyebrows - as Caring was never considered a particularly special business by the local investment community before.
At around the same time, SEM’s other subsidiary 7-11 Malaysia also announced a few changes. Namely, it introduced its new Ready-To-Eat segment (RTE) called 7 Café - which basically targets the QSR price niche sitting in between McDonald’s and Starbucks. RTE is simply a kitchenette in a typical convenience store which allows the sale of freshly-made food & beverages - with a dine-in area to mimic a full-fledged QSR experience. The Tiktok video below shows what a recently-opened 7 Café looks like:
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The main appeal of 7 Cafe to shareholders is that it introduces an F&B margin mix into 7-11’s existing FMCG Retail business. Given that the former tends to have Gross margins of ~30% while the latter tends to sport Gross margins of ~70%, this development has the potential to significantly ramp up 7-11’s legacy earnings. For instance, a 50:50 mix between the two could theoretically yield Gross margins of 50% - which would imply a +66% increase in Gross Profits.
Aside from that, the existing 7-11 Malaysia business is objectively quite impressive. In my previous article about SEM linked below, I pointed out some of their key attractions:
It has a negative Cash Conversion Cycle (CCC) - primarily due to its ability to pay suppliers on credit terms while receiving cash from customers upfront.
This CCC enables them to lever up to the gills (D/E: 600%) without fear of bankruptcy. (Their lenders have apparently been happy to support this degree of financial leverage over the past decade as well)
The dividend policy has historically hovered around 80%-100% over the past decade.
They also have 2,400 stores in Malaysia - equivalent to 72 stores per million population. For reference, 7-11 USA only has 27 stores per million population.
Unfortunately, these business moats are also well-recognized by the market, which might explain why the company has historically traded at between 20-30x PE throughout the past decade - despite posting relatively flat earnings growth over that period. This reflects typical Branded Retail multiples - given all the advantages that Branded Retail businesses offer, as I’ve discussed previously in my recent article about Innature (i.e. The Body Shop).
However, the aforementioned two developments have resulted in the status quo changing quite a bit for SEM - an assertion which is supported by a recent announcement made by FamilyMart Malaysia, a direct RTE competitor to 7 Café. In their latest 2Q report, FamilyMart’s parent company QL broke out the convenience store chain’s PBT for the first time - revealing that it had earned an RM 43M PBT during FY22 (screenshot below). This is all the more startling when you consider that FamilyMart had only started in Malaysia in 2017 - and became profitable in 5 years despite being impacted by the lockdown-affected years of 2020 and 2021:
Furthermore, it was reported way back in March 2022 that 7-11 Malaysia was apparently being courted by a potential acquirer - who is supposedly the operator of both the 7-11 and Starbucks franchises in Taiwan.
What is even more intriguing is that despite all of these new developments taking place in 2022, SEM’s share price hasn’t really budged from its pre-pandemic levels yet. Assuming Caring’s aforementioned divestment value of USD 400M as reported by Bloomberg is paid out as a special dividend, that would amount to a whopping RM 1.44 in special dividends per share. That’s over 90% of SEM’s current share price of RM 1.55!
Clearly, the market does not believe that Caring is capable of being sold for this price. In this SEM stock report, I will explain why I think that the market might have overlooked this aspect of the valuation - and attempt to estimate what Caring should be worth. We will also explore how much incremental value 7 Café could add to SEM’s residual valuation - and aggregate the two to estimate what the entire SEM Group’s fair value is like.
Recent news articles about Caring’s potential divestiture:
Paid subscribers can download this 1-page summary sheet + Excel financial model of SEM’s historical three statements… at the bottom of this report!
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Is Caring Pharmacy Worth USD 400M?
Fortunately - and as mentioned above - Caring was a listed company prior to 2020 - so there are ample audited financial figures available to us for us to analyze what their steady-state valuation should look like.
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