This article first appeared in The Edge Financial Daily, on October 12, 2015.

Maintain neutral: According to news reports, Malaysia has won several concessions in areas considered as sensitive, such as bumiputera interest and government procurement, in the Trans-Pacific Partnership (TPP) agreement negotiation rounds, and that the Malaysian government stood firm that the TPP should not hinder the public’s accessibility to affordable drugs.

However, until there is more clarification in the official release of its text, the TPP poses risks to all drug makers based in Malaysia.

The Malaysian Medical Association believes the TPP agreement would extend the exclusivity period of new drugs, the period when the drug originators have exclusive marketing rights.

Currently, generic drug makers rely on new product launches to offset the declining profit margin of older generic drugs. A longer exclusivity period means that generic drug makers may have to hold back their product launches and suffer an overall decline in profit margins.

We believe the TPP will subject government procurement and state-owned enterprises to greater competition as the International Trade and Industry Ministry was not able to totally carve out these areas from the TPP.

The government is the key customer of state-owned drug makers such as Pharmaniaga Bhd and CCM Duopharma Biotech Bhd.

Their manufacturing profit margins are higher than those of their peers and their earnings are at risk should competition intensify.

While the TPP should reduce or remove the barriers of exporting drugs to other TPP member countries, most local pharmaceutical companies focus mainly on the domestic market.

Those with the ambition to expand beyond Malaysia, such as Hovid Bhd and Pharmaniaga, are eyeing emerging markets like Nigeria, the Philippines and Indonesia, which are not involved in the TPP.

The TPP may take a few years to come into effect, and its impact on the earnings of local drug makers may only be felt in the longer term.

As such, we keep our earnings forecasts and target prices for Hovid and Pharmaniaga.

Nonetheless, the TPP still poses a risk to the sector’s valuation as it could alter the sector’s long-term prospects. We may review our valuation basis for these stocks when we gather more details about the pact. — CIMB Research, Oct 8