Pharmacy U

Pharmacists should read their Hemingway

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The state of the union for current pharmacy owner finances, both personal and corporate, is best described as being a mix between “For Whom the Bell Tolls” and “The Sun Also Rises.” 

 

by Mike Jaczko and Max Beairsto

 

No, we are not suggesting that Hemingway wrote two of his best novels with pharmacists in mind, but we are saying the following:

Many western economic countries have recently completed a 34-year decline in prevailing interest rates.  As central banks around the world, particularly in North America, set their sights on “normalizing” interest rates, pharmacists and pharmacy owners need pay attention.

Predicated on cheap debt, many pharmacists and new pharmacy business owners have continued to accumulate significant debt loads at an accelerated rate over the past 10 years. Historically, interest rates have been artificially depressed as a response to the global credit crisis in 2008.  Consequently, as retiring pharmacy business owners sell their stores to new owners, the complexion of independent pharmacy business balance sheets is steadily shifting from surplus retained earnings and cash balances to burgeoning financial debt and resultant leverage. First and second mortgages facilitated by vendor take backs, corporate car leases and maxed-out operating lines of credit provides the evidence.

Now, we are not predicting the end of the Canadian consumer economy or retail pharmacy businesses.  We are suggesting the following:  Regardless of whether you are an individual person, a corporation, a province (read: Ontario is broke) or a sovereign nation, if you continue to repeatedly spend more than you take in year after year, over time “the bells may begin to toll” regarding your leverage.

Modern economic theory insists that central banks must begin to normalize (read raise) interest rates from artificially depressed rates shortly, in fact the process has begun in our view. We don’t have a problem with this happening as long as the rates rise slowly over an extended period of time (years not months).

History Lesson

In 1993 interest rates in Canada moved from 6.93% to 9.93% in the span of three months. We are not suggesting that the economic circumstances of today mirror those of 1993, but we are suggesting that sooner or later someone is going to “take away the punch bowl”.  Get ready because the day has come.

Asset Repricing

A fundamental premise in finance describes that all financial and real assets (by proxy) recalibrate every time there is a significant movement in interest rates. Bond (aka debt) math shows that every 200-basis point rise in prevailing interest rates, holding all other factors constant, results in a 17% decline in the value of a bond in order to keep principal and interest payments, namely debt servicing constant. In other words, as interest rates rise, bond investment values drop, the value of real estate funding by dropping bond values falls in unison. Finally, pharmacy business owners need to recognize that when it comes time to refinance your mortgage after the first five years of debt servicing, your debt servicing costs will rise as sure as “The Sun Also Rises.”

Mike Jaczko, BSc Phm, CIM® is a pharmacist by background, is a portfolio manager and partner of KJ Harrison, a Toronto-based private investment management firm serving individuals and families across Canada. For more information, email: mjaczko@kjharrison.com.

Max Beairsto, B.Sc. Pharm., MBA, CVA is a certified valuation analyst and business intermediary with Enterprise Valuators, an Edmonton-based valuation and business sales advisory firm. Their Pharmacy Edge division assists pharmacy entrepreneurs across the country needing transactional and valuation advice. For more information, email: max@enterprisevaluators.com