This article first appeared in Corporate, The Edge Malaysia Weekly, on May 9 - 15, 2016.

WITH 107 outlets, Caring Pharmacy Group Bhd is closing in on its pre-initial public offering (IPO) pledge of expansion. Yet, its earnings growth has not matched the rising number of stores.

Back in 2013, the community pharmacy chain told investors that it would increase the 85 stores it had to 120 by the end of its financial year ending May 31, 2016 (FY2016). Implicit in Caring’s aggressive expansion plan — opening 10 stores per year from FY2014 to FY2016 — is the promise that its earnings will grow hand in hand with the number of stores. Over time, new outlets that have passed the initial gestation period not only contribute to the top line but also reduce the cost of sales resulting from improved economies of scale.

Based on that, analysts had expected Caring to experience double-digit growth in revenue and profit in the first three years after its IPO. Some were convinced enough to issue “buy” calls on its stock. But so far, the company appears to have fallen short of market expectations.

Its revenue grew from RM300.42 million in FY2013 to RM367.24 million in FY2015, representing a compound annual growth rate (CAGR) of only 6.9%. Its net profit fared worse, experiencing a negative CAGR of 16.45% — falling to RM13.02 million in FY2015 from RM22.32 million three years before. As a result, Caring’s earnings per share (EPS) almost halved from 11.25 sen in FY2013 to 5.91 sen in FY2015.

The company’s latest quarterly financial report also offers investors no comfort.

In the nine months ended Feb 29, 2016 (9MFY2016), the company reported a revenue of RM294.25 million, up 8.5% year on year, but its net profit plunged 56% y-o-y to just RM4.5 million.

Caring attributed the better revenue to higher sales at existing outlets due to aggressive and extensive promotional campaigns. The net profit letdown was due to smaller margins arising from lower selling prices in a competitive market. Meanwhile, Caring’s EPS for 9MFY2016 fell to just 2.09 sen.

Patience is thin among the analysts who track the stock. After the 9MFY2016 results were announced, BIMB Securities reiterated its “sell” call on the stock with a target price of 92 sen and revised its FY2016 and FY2017 earnings forecast downwards by 45% and 28% respectively. RHB Research also has a “sell” call on the company but with a higher target price of RM1.35.

HLIB Research, which has been tracking the company since early 2014, went a step further, ceasing coverage “due to its continuous set of disappointing results and lacklustre earnings prospects”. Its last target price was RM1.16 based on a price-earnings ratio of 20.9 times calendar year 2017 EPS.

The prognosis for Caring’s earnings has been varied. When contacted by The Edge, Caring declined to comment on its financial performance.

However, HLIB Research, in an April 28 note, points to the company’s over-aggressive expansion appetite, which has dragged down its earnings. “We believe earnings were heavily affected by Caring’s over-aggressive expansion appetite, where it opened some of its outlets in competitors’ territory … In the future, due to higher competition, we believe the group will be affected by its lower selling prices, which will ultimately affect its margins.”

Forging ahead with more store openings means the downside risk to Caring’s earnings remains for the immediate term. The start-up expenses and the cost of employing the services of a qualified pharmacist are growing pains that will continue to hurt the company’s earnings.

Furthermore, if lower selling prices stemming from increased competition is a challenge for Caring, things could get worse. Many of the company’s competitors have also embarked on an expansion trail.

For example, Guardian Malaysia, a pharmacy, health and beauty store chain owned by Hong Kong’s Dairy Farm International Ltd, pledged RM20 million at the end of 2015 to its rebranding campaign and expanding its store count to 499 in Malaysia.

Meanwhile, private equity firm Creador has invested RM100 million in RedCap Pharmacy, which it acquired in April 2015. There are eight RedCap stores in the Klang Valley at the moment but Creador is targeting to grow this to 70 throughout Malaysia by the end of this year and 300 over the next three years.

It is also understood that Berjaya Corp Bhd’s indirect subsidiary, Morning Charm Sdn Bhd, has entered into a joint venture to roll out a chain of pharmacies under the Chemist Warehouse brand.

It is worth noting that Caring’s aggression has been a constant feature of its growth and is what made the stock’s story compelling. The company came to the market with an impressive track record, having registered a three-year CAGR of 20.9% in revenue as it increased its number of outlets from 46 in FY2010 to 81 in FY2013, before its listing. Using RM18 million or 41% of its IPO proceeds to set up more stores was merely a continuance of the company’s tried-and-tested strategy.

“It is not the expansion strategy that is the problem,” an analyst watching the stock closely tells The Edge. Rather, it is an overall weak market environment where consumers are unwilling to spend on non-essential items, which makes boosting sales without sacrificing margins difficult.

“The problem with Caring is that its outlets are really just sophisticated 7-Eleven stores that have a pharmacist and sell high-value items like supplements. This means that they have very high overheads. The current market environment where consumers are not spending is also not helpful to Caring. If this carries on, the outlook for Caring is very bad.”

Nevertheless, the company is not oblivious to such challenges. In response to the weak market environment, Caring has kept itself nimble and willing to modify its growth strategy.

In FY2015, it closed three underperforming outlets (two complex outlets and one speciality retail outlet) and relocated one complex outlet to stem the rot. It also ventured into an e-commerce platform to sell its products online.

Caring has kept its balance sheet strong despite its expansion and falling profit. It still had RM69.6 million in cash and cash equivalents as at 9MFY2016. These factors do not make a great growth story but the analyst says such prudence appeals to many investors.

Shareholders, including Tan Sri Vincent Tan’s Jitumaju Sdn Bhd (5.29%) and Perbadanan Nasional Bhd (12.76%), have remained unmoved. The stock has largely held up since its 9MFY2016 results were released. It closed 14 sen or 8.48% higher at RM1.79 last Thursday, giving the company a market capitalisation of RM389.69 million.

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