Initiating Coverage on the Drug Stores
Investment Summary
We are initiating coverage on Canada’s two public drug store chains:
• Shoppers Drug Mart Corp. (SC-T) is rated BUY, with a $61.00 target. We
believe that the shares have been held back year-to-date due to several
concerns being circulated, all of which are unfounded in our opinion. We argue
that Shoppers will continue to grow its square footage in excess of 10%
through 2009, with sales/ft growth coming from both new/”touched” stores as
well as stores that have not yet been “touched” as part of the company’s major
renovation and expansion program. This, combined with an increasing
penetration of private label and directly-sourced seasonal products and
Shoppers’ unique ability to neutralize the effects of the recent regulatory
changes, is expected to drive an EPS CAGR in excess of 15% through 2009.
• The Jean Coutu Group (PJC) Inc. (PJC.A-T) is rated HOLD, with a
$15.50 target. In our view, Jean Coutu holds a dominant and almost
untouchable position in the attractive Quebéc drug market, and this positions it
well for steady earnings growth. Unfortunately, its franchise model does not
offer the same margin expansion opportunities as Shoppers, and this is
expected to prevent Jean Coutu from generating double-digit EPS growth. The
shares appear almost fully valued, based on our view that a sale or
privatization is not imminent and given our outlook for internal growth for the
next 12 months.

Table Of Contents
Investment Summary.............................................................................1
Our Investment Thesis Summarized ....................................................3
What Moves Drug Store Stocks? ..........................................................9
Which Company Produced the Most Shareholder Value? .......................... 10
Industry Analysis And Outlook ..........................................................11
Prescription Drug Industry – Outlook Remains Promising......................... 11
The Question Is: With Government Health Spending on the Rise….......... 13
…Is This Level of Spending Sustainable Longer Term? ............................ 14
Generics Are Being Counted On To Help Contain Drug Costs….............. 16
…Which Is Positive for Retailers But Negative for Wholesalers ............... 18
Which Company Does Pharmacy Best?...................................................... 18
Regional Overview And Outlook................................................................ 20
Script Trends Summary............................................................................... 30
The Front Store – Leveraging The Traffic ........................................31
Category Expansion Provides More ‘Pullers’ ............................................. 31
Beauty Care – Those Not Going Up-market May Be Left Behind ............. 31
Private Label Has Lots of Potential, But It Will Not Be Easy .................... 35
Which Company Does Front Store Best?.................................................... 37
Consolidation Is Expected To Ramp Up..................................................... 39
Shoppers Drug Mart Inc. ....................................................................46
Investment Summary .................................................................................. 46
Our Views Summarized: Don't Believe All the Negative Stories............... 48
Company Profile ......................................................................................... 53
Format Strategy........................................................................................... 54
Front Store Strategy .................................................................................... 59
Major Initiatives .......................................................................................... 62
Banner Strength + Loyalty Program + Convenience =
Premium Prices/Margins............................................................................. 64
#1 Nationwide, But Expansion Opportunities Remain ............................... 66
In Summary, Growth Drivers Remain Plentiful.......................................... 68
Financial Position And Outlook.................................................................. 68
Justification of Target Price (Valuation) ..................................................... 75
Key Risks to Target Price – Overall Risk Rating: MEDIUM ..................... 79
The Jean Coutu Group (PJC) Inc. .....................................................84
Investment Summary .................................................................................. 84
Company Profile ......................................................................................... 86
The Brooks/Eckerds Divesture – A Transforming Event............................ 88
So What Does Jean Coutu Do Now?........................................................... 91
Internal Growth – What Is the Potential?.................................................... 97
Growing the Front Store.............................................................................. 97
Financial Position – a Reversal of Fortunes.............................................. 103
Financial Forecasts.................................................................................... 104
Justification of Target Price (Valuation) ................................................... 108
Key Risks to Target Price – Overall Risk Rating: MEDIUM ................... 112
APPENDIX A. IMPORTANT DISCLOSURES ............................117

Our Investment Thesis Summarized
What a great industry! Particularly for those with scale and clout. It arguably has
inherent growth and stability stemming from the aging population and new
treatments that use multiple drugs, both of which are driving pharmacy sales
growth at a very healthy pace. More importantly, one would probably have to go
back to before the Wal-Mart revolution to find another North American retail
sector – particularly one focusing on consumer staples – where price was not a
principal mode of competition. But this is exactly the case for the domestic drug
store industry where almost all prescription sales (the majority of industry
revenues) are reimbursed by public or private plans, and many key categories that
pull customers into the store (e.g., prestige cosmetics and Canada Post outlets)
operate with at least quasi-mandated pricing.
So, without being compelled to constantly invest in price, the quality of one’s
merchandising strategy, customer service and balance sheet (to invest in and grow
the network) can actually be the primary driver of relative bottom line
performance. Of course, being of dominant scale is also significant when it comes
to:
• offsetting pressures from regulatory changes (e.g., Bill 102);
• funding marketing and loyalty programs; and
• sourcing product cheaply, domestically or internationally.
As the largest drug store chain in Canada, Shoppers definitely has this scale. We
believe that it also has a proven internal growth strategy with legs for at least
another five years, as well as the cash flow and balance sheet strength to capitalize
on acquisition opportunities.
Jean Coutu’s scale is not in the same league as Shoppers, but its dominant position
in Québec makes it an important drug retailer, while its franchisor/distributor
format shelters it from serious direct hits from the new legislation. It too has a very
strong balance sheet, but its ability to create incremental shareholder value with it
is in question.