This article first appeared in The Edge Financial Daily on May 18, 2017

Pharmaniaga Bhd
(May 17, RM4.82)
Maintain hold with an unchanged target price (TP) of RM4.90: Pharmaniaga Bhd’s first quarter ended March 31, 2017 (1QFY17) revenue grew to RM618.3 million (+10.6% year-on-year [y-o-y]), mainly thanks to improved overall demand from government and private sectors. 

However, core net profit only rose 3% y-o-y to RM18.9 million due to higher raw materials costs and overall operating expenses (+12.4% y-o-y). This was despite a decline in total finance costs (-15.4% y-o-y) and lower amortisation charges from its Pharmacy Information System (PhIS) of RM3.6 million (-56.9% y-o-y). 

Accordingly, earnings before interest, taxes, depreciation and amortisation margins also declined to 7.5% (-1.5% points y-o-y).

Pharmaniaga’s logistics division showed improvement. 1QFY17 revenue and profit before tax rose 8.8% and 146.7% y-o-y to RM440.4 million and RM2.2 million respectively. 

This was attributed to higher economies of scale from an increase in offtake of products from both government and private sectors. Indonesian operations also turned profitable, thanks to lower finance costs and production rationalisation efforts.

However, contribution from the manufacturing division was slightly weaker in 1QFY17 due to higher operating expenses.

We believe that the worst is over and expect 17.7% earnings per share growth in FY17. This should be driven by ongoing efforts to improve inventory management in its logistics division, leading to lower finance costs for working capital funds. 

We also expect annual amortisation charges to be lower given the amortisation period for the PhIS has been extended from four years to 14 years. Moreover, the group should benefit from growing demand for its manufactured products and services.

A potential catalyst would be the renewal of its concession agreement with the health ministry (MoH), which is due to expire by 2019. Previously, management had said that it was confident of securing a 10-year extension to its concession agreement with the MoH by end of 2017, barring unforeseen circumstances. 

We opine that the group’s proven track record and extensive logistics and distribution network would ensure it keeps an unassailable edge over its peers.

Our TP remains at RM4.90, still based on an unchanged 18.7 times 2018 price-earnings (in line with five-year historical mean). Although yields of 4% to 5.9% for FY17 to FY19 are attractive for a healthcare-related stock, current valuations have reflected the weaker government demand given the cutbacks in the MoH’s budget for drug purchases. — CIMB Research, May 16