Raia Drogasil
A secular growth stock $RADLY $RADL3
Everyone in the US will be familiar with Walgreens. Three quarters of the population has one within 5 miles of their home. Far fewer will recall Walgreens fondly as a phenomenal growth stock.
“Really, when? The 1950s?” I hear you asking. No, try the 90s and 2000s when the stock compounded at 27% and 26% over the respective decades. That sounds great but just to fully elucidate how great, that translates into a hundred-fold increase in the shares from 1980 to 2000. No wonder Jim Collins included the company in his famous business book, Good to Great, first published in 2001.
Ok, but absent a time machine, who cares?
Let me introduce Raia Drogasil (RD).
RD is the largest drugstore chain in Brazil with 16.5% market share nationally by sales and the result of the 2012 merger of Drogasil and Droga Raia. The respective sides were owned and managed by Brazilian-Italian families, the Oliveira Dias and Pipponzi clans. They have enjoyed a wonderful marriage since with a combination of professional and family management and continue to own 25% today.
Drugstores are a great business because of course pharmaceutical drugs are non-discretionary and convenience is important. However, in contrast to other retail formats, each location requires a trained pharmacist on site which represents a barrier to entry and also limits capacity expansion (i.e. helps avoid overcapacity).
That said, the Brazilian drugstore industry went through a boom and bust cycle in the early 2010s epitomized by a group of shiny suited investment bankers patching together 4 regional chains into the country’s 4th largest operator and taking it public in 2011 before eventually limping into bankruptcy 8 years later. CVS also dipped a toe into the country and got burned, as did Brazil’s leading gas station operator.
After its formative merger in 2012, RD eschewed many M&A opportunities, both on the way up and the way down the industry rollercoaster, preferring to gradually and meticulously build its business organically [though they did buy CVS’s chain of 50 stores in 2019 for less than the book value of the assets].
Today RD is by far the largest operator nationally, with 3,200 pharmacies, leading privately owned Drogaria Pacheco Sao Paulo (DPSP, also a 2011 merger), and publicly listed Pague Menos (Pay Less), whose former Chairman once lamented the soaring inflation in the cost of bribes. DPSP and Pague Menos have 1,300 and 1,650 stores respectively.
According to the industry body Abrafama, the top 5 chains have only 33% market share, vs 81% in the US. Much of the market, particularly in smaller towns and cities, continues to be made up of individual pharmacists with a single store, of which there are over 50,000. RD’s 3,200 pharmacies compare against over 100,000 nationally (per the National Institutes of Health), but generate a disproportionate share of sales, hence their 16.5% market share. This chart demonstrates well how the company exploits its superior branding, sourcing and logistics to outcompete its peers:
Reinvestment Opportunities
Let’s return to Walgreens in its heyday to see what lessons we can glean. You can see from the chart below that through the 1990s Walgreens’ sales compounded at an impressive 13% but nowhere near the 26% the stock compounded at. The reason that the stock was such a monster is indicated further down the chart. The company delivered a very consistent 26% return on invested capital, and it delivered this while reinvesting almost all of its cashflow. i.e. the increasing denominator had no impact on returns.
It is exceedingly rare to find an opportunity to invest at a 26% annualized returns and Walgreens had one in expanding its store network. If there is any secret formula in investing this is it, as the market tends to undervalue this reinvestment opportunity, particularly when it is persistent.
Below are the equivalent numbers for Raia Drogasil in US$:
I have made a couple of adjustments here, firstly to remove a large amount of goodwill dating back to the 2012 merger which doesn’t reflect on their reinvestment opportunity. Secondly there was an accounting change in 2019 which brought lease liabilities onto the balance sheet. I don’t think we need to get into a lengthy debate about the proper accounting for leases, but I wanted to make the numbers comparable to Walgreens.
In any case we can see that Drogasil has opportunities to reinvest lots of capital at high rates of return, and have already established that the company has a wonderful growth trajectory ahead of it.
The company breaks down its market share by region. You can see the gains they’ve made over the past decade. They’re now at 29% share in the largest, richest and most competitive state of Sao Paulo (where they generate over 40% of sales). With organic expansion I don’t see why their share can’t go even higher there and there is plenty of scope to grow elsewhere.
The company has been extremely methodical in its expansion. They never hire externally for store managers preferring to train and promote internally. This creates growth opportunities for employees (and thus loyalty) but also limits the speed of expansion. You can also get a sense for how disciplined they’ve remained in the number of costly closures of locations they are forced to make:
These are small stores on short leases so a 1% annual failure rate is very impressive.
Earlier this year the firm moved on to their third CEO since the 2012 merger, promoting Renato Raduan who had been Director of Retail Operations for much of the past decade. At the same time Marcello de Zagottis, nephew of the Chairman, was elevated to Chief Operating Officer. Marcello and his brother Eugenio – who are part of the Pipponzi family – have been instrumental in building the business. Eugenio has moved up to the board room in this reshuffle. I expect the management team to continue to execute well.
Not only is there a geographic and market penetration opportunity but also there are a couple of other key tailwinds. The first is demographics. Brazil has a rapidly aging population as the company shows below:
The second point is that the vast majority of prescription drugs purchased in Brazilian pharmacies are paid for out of pocket, i.e. they are not typically covered by either the universal healthcare system or by private health insurance (which covers about a quarter of the population). Any change here would increase accessibility and prove a tailwind for RD and the drug store industry.
Looking Forward
Here are the historic and forward looking numbers in US Dollars:
The slowdown in growth shown above in 2024 is a function of currency translation. In local currency terms sales rose 14%. I’m not sure why the 2025 estimate is similarly low, but I would take the over - the company is guiding for 11% store expansion.
I like to keep my valuations nice and simple – better roughly right than precisely wrong – so I won’t get into the nitty gritty of why businesses with high reinvestment opportunities deserve higher ratings (perhaps a subject of another article!). Suffice to say that RD has rarely traded below a 20x Price/ Earnings (5% earnings yield) over its history. I will use this as my base case, and use 25x P/E (4% earnings yield) for a slightly more optimistic scenario.
With 10% dollar growth out to 2030 and some modest improvement in margins (3.6% net), the company should be earning $460m in profit. A 20x P/E implies a 9% annualized dollar return (plus 2% in dividends), while the latter is a 14% annualized return (plus dividends).
Risks
Pharmacies are regulated businesses, as I alluded to before. In Brazil, the price of prescription drugs is subject to a cap, and pharmacies are quite restricted in what they can sell – you won’t find any candy or soft drinks in the aisles for example. I view the latter more as an opportunity than a risk however (deregulation), and I’m not too worried about the former. The price caps are adjusted for inflation annually (Brazil has a long history of inflation after all!) and RD sells well below these caps, taking advantage of its efficiencies over small chains and individual pharmacies that can’t make money at lower price points. Ultimately these are very thin margin businesses, hence the regulator can’t refuse price rises for long without inflicting a lot of pain on retailers, first and foremost the small chains and independents.
A second area of risk is around a shift towards online procurement of drugs. This has been slow to take off in wealthy economies, and there are a number of reasons why consumers continue to visit drugstores, not least the desire to interact with a pharmacist and the demographic of the typical consumer. However, according to a study by the Alliance for safe Online Pharmacies Foundation 52% of Americans have purchased medications from an online pharmacy for themselves or someone in their care, up 10% from 2021 so adoption is increasing.
RD has already made an impressive start here, jumpstarted by the pandemic and is originating 20% of its sales online, of which 2/3rds are picked up in store and a further 30% delivered to the customer within an hour. The company is certainly alert to the threat and well positioned to adapt.
Moving on to the macro, President Lula is more of a spendthrift leftist than an expropriative leftist. He and his party face elections in just over 18 months time and currently experience low approval levels (record low for Lula’s collective 10 years in office). Hence no doubt they will try to spend their way into the good graces of the electorate. In a high interest rate economy like Brazil, government largesse tends to spike interest rates and weaken the currency which serves to squeeze the private sector causing the consumer and corporate sector to slow down.
If I know that, of course so does everyone else, the question as always is what is in the price. 10 year government bond yields are already almost 15% in Brazil (6.5% in Dollars) vs 5% inflation, enough to have quite a dampening effect on the private sector, while the currency is close to the lows – see below:
So I’m not overly worried about the macro/ currency risk. RD is clearly not a cyclical business, its products are not bought on credit and is outgrowing an industry which itself consistently far in excess of GDP due to the growth tailwinds I’ve elaborated.
I like the stock. Buy.
Disclaimer
This article is purely for informational and entertainment purposes and should not be construed as investment advice. Please consult a financial advisor before making any investment decisions.
Please also assume that I own and intend to trade any stocks discussed before and after dissemination of this report.
Are sales more concentrated on drugs than Walgreens which acts like a more general retailer with a pharmacy attached? How does Walgreens revenue break down between pharmaceuticals and other? If you were to split Walgreens into pharmaceuticals and “other” which is the better business? Longer term does increased regulation and more covered expenses (insurance/universal healthcare) advantage them over mom-and-pops who can’t manage the paperwork, or hurt them because they’re an easier target?