China Nepstar: Now Is The Time To Buy, Upside Ahead

| About: China Nepstar (NPD)

China Nepstar Chain Drugstore (NYSE:NPD) is China's largest retail drugstore. Founded in 1995 with one store, it currently has 2,050 stores in 76 cities. In terms of the business model, it's essentially your local drugstore, only in China.

China Small Caps: The Risk

With a market cap of only $195 million, China Nepstar is definitely a small cap. Many investors have grown suspicious of Chinese companies and there were many outright frauds that went public by RTOs that short-sellers had a field day with in 2010-2011. I still think that there are fraudulent Chinese companies trading in the US. For example, myself and several others wrote short reports on FAB Universal (NYSEMKT:FU) suggesting that massive dilution was coming. The stock had been hyped, and was at $10 when my article came out. The excellent investigative work of the AlfredLittle group showed that FAB Universal had pirated its content. Later work by the GeoTeam showed that FAB had issued Chinese bonds without telling investors. The stock was promptly halted and hasn't traded since.

I believe that there is definitely fraud in many Chinese names, so the goal should be to do as much due-diligence as possible, and minimize as much risk as possible.

China Nepstar went public in November of 2007 on the NYSE. The IPO was underwritten by Goldman Sachs (NYSE:GS) and Merrill Lynch. Goldman, which was an early investor in China Nepstar, remains the top institutional owner today. The auditor is KPMG, a big four auditor.

Investment Thesis

The last few years have been challenging for this industry. NPD Revenue (5 Year Growth) Chart

NPD Revenue (5 Year Growth) data by YCharts

Revenue growth has dropped from 40% to now just 8.75% over the past 5 years. More importantly, margins have come under pressure over the same time period. The stock chart looks very similar to the revenue growth stock. (The stock is down 57% over the past 5 years.) I think that now is a good buying opportunity. Management provided the following update during the third quarter conference call.

Revenue for the third quarter of 2013 increased 7.7% to RMB683.2 million or US$111.6 million from RMB634.6 million for the same period in 2012. Same-store sales for the 1,925 stores opened before December 31, 2011, and are still operating, increased by 10.5%, again this was primarily due to promotional initiatives aimed at increasing store traffic.

Looking at the chart, it appears that the slowdown in revenue growth has bottomed, and management has been focused on turning things around. Management has been closing down unprofitable stores and improving the product mix to increase profitability. In terms of increasing revenue growth, the company has been increasing promotional activities and marketing campaigns. This appears to be working as same-store sales were up 10.5% YoY. Despite the increase in marketing and promotional activity, Sales, Marketing, and other expenses as a percentage of revenue were down to 38% from 40% in the same quarter last year. This was mainly due to the closing of unprofitable stores. So that is the good, this is the bad;

Loss from operations in the third quarter of 2013 was RMB8.5 million or US$1.4 million compared with income from operations of RMB4.2 million in the same period in 2012. The loss from operations in the third quarter of 2013 was mainly due to lower gross margin and the above mentioned RMB5.7 million or US$0.9 million penalty.

Although the loss in the quarter was partly due to the RMB 5.7 million penalty, which was a one time tax issue, the main issue here is gross margins. As stated earlier, China Nepstar has been engaging in increased promotional and marketing activities. During this time period the retail pharmacy industry in China has struggled.

While this strategy has had a near-term impact on our gross margin, we believe we will make it up through positive contributions to our market share, customer relationships and long-term growth prospects.

I think that China Nepstar has been positioning itself well, and will benefit from increased market share as the general industry rebounds. Management has said that they are planning on opening more stores beginning middle of next year. This should help revenue growth continue upwards next year.


On first glance it does not appear to be the cheapest stock, trading at 38x forward P/E and 8.63x EV/EBITDA.

China Nepstar announced its annual dividend on November 26. The dividend will be paid to shareholders of record on December 20, 2013 and the dividend will be paid around January 24, 2014.

China Nepstar Chain Drugstore Ltd. (NPD) ("Nepstar" or the "Company"), the largest retail drugstore chain in China based on the number of directly operated stores, today announced that the Board of Directors has declared an annual cash dividend of US$0.32 per American Depositary Share (ADS), which represents a total value to shareholders of approximately US$31.59 million. The distribution of the dividend is conditional upon the approval of the relevant PRC government authorities. The annual dividend is payable before or around January 24, 2014 to shareholders of record as of the close of business on December 20, 2013.

At the current share price of $1.91 this represents a 17% yield.

I think that it would be smart to establish an investment in NPD so you are a shareholder of record on or before December 20th. The stock will drop when it goes ex-dividend, but the fourth quarter has historically been a strong one for China Nepstar.

Disclosure: I am long NPD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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