Should you subscribe to MedPlus Health IPO?

MedPlus Health Services (MedPlus) with 2,326 pharmacy retail stores across several States in India, operates the second largest pharmacy retail in the country with a modern format. Pharmacy retail in India is dominated by independent pharmacists, with increasing presence of online e-commerce players. MedPlus’ operations are placed between the two models. The modern brick & mortar retail store (B&M) accounting for bulk of the sales also doubles up as online fulfilment centres in hyperlocal markets.

The IPO values the company at ₹9,500 crore, consists of a fresh issue of ₹600 crore and an offer for sale of ₹789 crore from non-promoter entities. The company can grow faster than the industry on the back of store growth and increasing efficiency of its established stores. But the capital-intensive retail operations of the company face competition from multiple fronts from those with either deep pockets or an established customer base. The risks from competing business models in an industry with low margins are not reflected in the premium valuations and investors should wait for a more favourable entry point.

Industry and company

Pharmacy retail as an industry is sized at ₹1.81 lakh crore in FY21 and is expected to grow at 10 per cent CAGR for the next five years, riding on Indian pharmaceutical market growth. Independent pharmacists account for 88 per cent of the market and B&M stores, including MedPlus, 8.2 per cent. Online-only operators account for a miniscule 2.7 per cent, but are growing at more than 100 per cent compared to 20 per cent for B&M and 8 per cent for independent in the last five years.

The industry is primarily marked by low operating margin range of 3-10 per cent, which covers a high 20 per cent customer discount that has become the norm. Even large US operators like CVS and Walgreens must contend with similar margins complementing rebates (discounts) with services and private labels to retain market share. The industry operates on cost-plus margin model, which is impacted by expanding pricing control on the list of essential medicines.

MedPlus stores have grown at a rapid pace in the last two years (30 stores per month opened in the last 18 months compared to 9.5 per month in the last decade) by utilising external funding (starting from April 2019 from Premji Invest and others) and a reliable cluster-based expansion model in targeted neighbourhoods. This approach helped the company set a diverse base across 7 neighbouring States, from Tamil Nadu to Odisha and Maharashtra.

The company is eyeing Delhi and Kerala (changed regulations recently) for its next phase. MedPlus is differentiated from independent pharmacists primarily by way of order fulfilment capability across 100,000+ SKUs and implicit guarantee in discounts and quality. High order fulfilment is the result of an in-house technology base that integrates point-of-sales data with the rest of the network.

Quality and pricing are ensured by MedPlus procuring higher up the supply chain, tied to large manufacturers, generally inaccessible to independent pharmacies.

MedPlus is keen on increasing private label sales contribution, currently at 13 per cent of sales primarily from generic medicines, to improve margins. But, extending private labels beyond simple old molecules may be difficult and private labels in FMCG products may demand retail space.

MedPlus is also increasing the proportion of online sales, which has steadily increased to 9 per cent starting with efforts for an omnichannel presence from 2015. MedPlus leverages its own fleet of drivers (who double as store staff), clustered presence in dense neighbourhoods, mobile apps and well-integrated store/warehouse network and is currently generating 2-hour delivery models with 93 per cent success in the pilot stage.

Medplus competes with the high and the mighty, independent pharmacists with high market shares and mighty (pockets) online players like Tata 1mg, Reliance-backed Netmeds and e-pharm leader Pharmeasy, apart from its own format players — Apollo Pharmacy and Wellness Forever.

Compared to Medplus, the independent pharmacies lack technological edge and online players lack service flexibility of physical reach. While synergies between the two are difficult owing to the thin margins in the industry, the competitive threat cannot be ruled out, posing a major overhang to B&M stores. This is in addition to large e-commerce retailers like Amazon and Flipkart eyeing pharmacy offering for a long time. The various entities carving their shares from independent pharmacists’ share — which itself may not erode significantly — can potentially keep the discounts high and margins low for prolonged periods.

Financials and valuation

MedPlus reported 16 per cent revenue CAGR in FY19-21 to ₹3,069 crore, driven by store count growth (12 per cent CAGR) and same-store sale growth of 8 per cent CAGR. The same-store growth can further improve to 12 per cent, according to the company, as stores consolidate their hyperlocal markets, aided by increasing private label and online sales. The company aims to improve store count addition to 50-60 stores per month, sustaining a high 20-25 per cent store count growth as well. The fresh issue proceeds earmarked primarily for working capital are meant for new store inventories, which account for the largest cost in new store openings. The company operates with high investments in inventory which stands at an average of 90 days in the last two years, typical of the industry. The company has a strong balance sheet with net debt to equity turning negative 0.05, as on September 30, 2021.

The company has reached strong EBITDA margin range of 7-8 per cent that can be compared to the higher end of even international pharmacy retailers, who operate from higher retail space for high margin product range. Even as revenue growth can sustain, the overhang of price competition in a low margin industry which is yet to witness significant digital disruption is noteworthy. The company is without listed peers for comparison but the IPO valuing the company at 2.5x EV/Sales and 30x EV/EBITDA (both based on H1-FY22 annualised financials) appears to be at a premium, primarily considering the competition in a mature industry.

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