China Nepstar Chain Drugstore's Flop Could Be Profitable

| About: China Nepstar (NPD)

Goldman Sachs usually provides investors with strong returns from IPOs it lead underwrites. However, China Nepstar Chain Drugstore (NYSE:NPD) turned out to be one of the biggest disappointments to the firm's credit.

Since coming public in November of last year at more than $16 a share, NPD has cratered. Last week, the stock may have reached a crescendo in price depreciation by hitting an all-time intra-day low of 3.87 following the company's Q2 earnings report. This capped off 17 straight days of selling on the unpopular drugstore chain.

I know how dangerous catching a falling knife can be for any investor or trader. However, in the case of NPD I ignored this sound advice after finding out the company is going to conduct a $40 million share buyback over the next 16 months on the open market and it will not alter its 2.5% dividend to stockholders. The dividend information and a majority of any other NPD business developments mentioned in this article are contained in the corporate earnings transcript supplied by Seeking Alpha. These two events were signs of confidence from the company that things are not as bad as the stock price would have them appear.

The company also continues to grow both organically and through acquisition, building 234 new stores in the recent quarter and announcing in August to buy 42 drugstores from Kangjie, a competitor. These stores are based in Qiangdong, where Kangjie was the second largest drugstore chain in operation. NPD will have over 2500 stores upon closing the deal.

Additionally, I am not the only one holding beaten down shares of NPD. Yahoo Finance reports that Goldman Sachs in its June filing is still holding 25 million shares, approximately 23% of the company.

Don't be mistaken, China's largest drugstore chain has its share of concerns. For one, China drugstores don't run like American drugstores. Federal regulations can be onerous and the pharmacy operation is not quite as lucrative and profitable as in the U.S. So to compare it to a Walgreens (WAG) or CVS (NYSE:CVS) just yet would not be quite accurate. Also, China is experiencing inflationary concerns in its overall economy which company management did point out caused the company some difficulty with rising SG&A, particularly that surrounding store rental and labor costs.

Finally, the company has had inconsistent margin growth, with the recent quarter showing some slight weakening in that area along with same store sales comps being down more than one percent YOY. Management attributed some of this to bad weather and natural disasters. Regardless of the excuse that number needs to turn positive and sooner rather than later.

Despite the issues mentioned above, I just find too much negativity already priced into this one. Sporting a $500 million market cap, NPD is now trading at approximately 1 to book and a forward PE of 14. I regard it a speculative buy with a small position in the low $4s. If this current bottom holds, I may add more in this range.

When should investors sell this stock? I have taken flack in the past from readers regarding the selling of a sliding recommendation, and with this as any other stock pick I think it depends on the individual, his or her discipline, and appetite for risk.

Disclosure: Long NPD.