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

Pharmaniaga Bhd
(Aug 17, RM4.20)
Upgrade to add with an unchanged target price (TP) of RM4.90: Pharmaniaga Bhd’s revenue for its first half of financial year 2017 (1HFY17) rose by 4.1% year-on-year (y-o-y), mainly due to a stronger contribution from the logistics and distribution division. Earnings before interest, taxes, depreciation and amortisation (Ebitda) margin, however, fell to 6% (-3 percentage points [ppts] y-o-y) as a result of a higher overall operating cost and production loss of certain manufacturing lines in its second quarter ended June 30, 2017 (2QFY17). 1HFY17 Ebitda fell by 24.4% y-o-y but net profit dropped by a narrower 14.2% y-o-y to RM28.6 million, due to a lower finance cost (58.3% y-o-y) and a lower tax rate of 23% (-6ppts y-o-y). Overall, net profit came in within our expectations, but below consensus.

As expected, Pharmaniaga recorded a weaker quarter-on-quarter (q-o-q) result in 2QFY17. 2QFY17 revenue declined by 16.2% q-o-q due to lower offtake of pharmaceutical products in conjunction with the Ramadan period as well as a sharp decline in contribution from the manufacturing division. Ebitda margin also weakened to 5.3% (-2.2ppts q-o-q). As a result, 2QFY17 net profit fell 48.6% q-o-q despite the group’s tax rate being at a low 2% in 2QFY17 due to the recognition of deferred tax assets.

The weaker contribution from manufacturing division was mainly due to a lower production output in 2QFY17. During the whole quarter, various production lines were temporarily taken offline for upgrading works in preparation for commercialisation of new products. We suspect these products are likely to be new tender drugs that Pharmaniaga will supply under the Approved Product Purchase List (APPL). These new drugs are likely to be rolled out at end-3QFY17 through to November 2019, for a duration of approximately 2.1 years.

A potential catalyst would be the renewal of Pharmaniaga’s concession agreement with Malaysia’s health ministry (MoH). The existing agreement is due to expire in 2019. The company said it is confident of securing a 10-year extension to its concession agreement (CA) with the MoH by end-2017. With Pharmaniaga’s proven track record and extensive logistics and distribution network versus its peers, we too think an extension of the contract is a likely outcome.

Given the recent share price decline, we upgrade Pharmaniaga to an “add” from a “hold”. Our TP is unchanged at RM4.90, still based on 18.7 times calendar year 2018 price-earnings ratio (five-year historical mean). We expect earnings to improve sequentially, especially starting from 4QFY17, boosted by a higher supply of drugs under the APPL, as well as news flow about the renewal of the CA. — CIMB Research, Aug 16