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This article first appeared in The Edge Financial Daily on June 12, 2018

Pharmaniaga Bhd
(June 11, RM3.63)
Maintain add with an unchanged target price (TP) of RM4.55:
Pharmaniaga Bhd’s share price declined 7.7% last Friday, due to concerns over its position as the sole concession holder to supply medical supplies and medicine to all medical facilities under the ministry of health (MoH). To recap, Pharmaniaga has held exclusive rights since 1994 under a concession agreement (CA) to purchase a list of medical products under the MoH’s approved product purchase list (APPL) from suppliers selected by the MoH, and distribute them to medical institutions under the MoH’s jurisdiction.

Under the CA, Pharmaniaga procures medical products at prices which have been predetermined by the MoH with its suppliers. It sells these products to the MoH at a fixed percentage markup over its purchase prices to cover its cost of inventory holding, distribution and potential inventory obsolescence. The CA was last renewed in 2009 for a period of 10 years, which will expire by November 2019.

Through a tender exercise (every three years), the MoH selects the suppliers of products for the APPL based on its own product specifications and criteria. While Pharmaniaga does organise these tender exercises under the CA, we understand that it does not play any part in the selection of suppliers by the MoH. Pharmaniaga’s own manufacturing segment also participates in these tenders.

As of financial year 2017 (FY17), revenue from the CA made up 49% of Pharmaniaga’s revenue, and was fully reflected under the logistics and distribution (L&D) segment (68.3% of FY17 revenue). In our view, margins for the CA business are thin given that the earnings before interest and tax (Ebit) margin for the overall L&D segment was 1.2% in FY17. Note that the L&D division’s FY17 Ebit only made up 17.7% of the group’s total FY17 Ebit, with the remainder generated by its manufacturing segment (69.3%) and Indonesia operations (13%).

According to media reports, the MoH’s budget for medical products was at around RM3.3 billion in the L&D segment (68.3% of FY17 revenue).

We estimate that only 33.4% of the MoH’s budget was used for the purchase of medical products under the APPL given that Pharmaniaga is the sole supplier under the CA. We believe the remaining budget of RM2.2 billion was used to purchase drugs which fall out of the APPL list, likely through central contracts and direct purchases.

Overall, we maintain our earnings estimates, “add” call and 12-month TP of RM4.55. This is still based on 15.9 times calendar year 2019 price-earnings ratio, a 10% discount to CIMB’s pharmaceutical sector five-year target mean. Its dividend yields of 5.4% to 7.2% (FY18 to FY20) should also appeal to investors. Downside risks include lower-than-expected demand for drugs from the MoH and discontinuation of the CA. — CGSCIMB Research, June 11

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