Core drivers of growth

Store openings (store number projected to double in next two years) and continued margin improvement driven by product mix change should be the key drivers of earnings. We look for earnings CAGR of 66% from 2007E to 2010E. Potential acquisitions could deliver further accelerate the growth rate, in our view.

Risks to the investment case

1) Nepstar has yet to show consistent positive same store-sales growth; 2) the company's gross margin may eventually see erosion due to competition; 3) potential acquisitions may dilute margins initially; 4) many of the markets Nepstar competes in have a high number of players and competition may intensify before consolidation takes place.

Valuation

Our 12-month target price is based on 41x '08E P/E, or 1.1X PEG, which is in line with the PEG ratio of US drugstores and HK-listed Chinese retailers. Industry context Low spending levels and channel shift away from hospitals offer strong secular growth outlook for modern drugstores in China.