Investment Highlights

• We reiterate BUY on Duopharma Biotech (Duopharma) with a  lower fair value (FV) of RM1.95/share (from RM2.06/share) to  account for our forecast adjustment, albeit based on an  unchanged FY23F target PE of 17x, at parity to its 5-year  average. There is no ESG-related adjustment based on our 3- star rating.

• After an analyst briefing yesterday, we reduced FY23F  earnings by 5% mainly to account for higher costs associated  with the commencement of K3 facility production in 2QFY23F,  as Duopharma does not intend to increase product selling  prices to pass along these costs this year.

• Duopharma’s K3 facility received the certificate of completion  & compliance (CCC) in Mar 2023. To recap, K3 is intended to  allow Duopharma to relocate the majority of K1’s equipment,  so that the older plant can be refurbished and upgraded to  meet the latest regulatory standards. Notably, K3 has 50%  more space than K1.

• K3 and K1 will be operated concurrently until the completion  of the full transfer by end of FY24F. This will result in higher  refurbishment/upgrade costs, electricity bills, depreciation,  labour costs totaling RM5mil to be recognised in FY23F.

• On a negative note, the increase in electricity surcharge from  3.7 sen/kwh to 20 sen/kwh in 1H2023 and the increase of  entitlement threshold for overtime work from ≤RM2K/month to  ≤RM4K/month effective Jan 2023 could raise Duopharma’s  operating costs by RM12mil-14mil (or 11%-12% of our revised  FY23F profit).

• Nevertheless, Duopharma indicated that the higher operating  expenses could be partially mitigated by hiking product  selling prices for the private and public sectors, in  conjunction with moderating active pharmaceutical  ingredients (APIs) prices. We believe Duopharma can pass on  the higher operating costs given the pricing power of  pharmaceutical industry. 

• Going into FY23F, we believe that Duopharma’s revenue  growth trajectory will continue especially from the ethical  classic products segment, driven by: -
   
  • (1) The Return of Patients to Hospitals for Elective Surgeries  (Exhibit 1), 
     
  • (2) Increased government allocation to Ministry of Health  (MoH) in 2023F, amounting to RM36.3bil (+12% YoY vs 10- yr CAGR of 7%) (Exhibit 2), and
     
  • (3) Addition of 5 public and 19 private hospitals scheduled to  be operational over the next 3 years.  
     
• The tender for new approved products purchase list (APPL) was open for a subset of drug items (60%-80% of total  drug items) since April 2023. The group believes that the contract should be awarded by the end of Jun 2023, prior  to the expiration of existing APPL. The remaining balance (20%-40%) may be extended to Dec 2023.

• We view this development positively as it allows Duopharma to revise product selling prices for the public sector to  better reflect the current operating environment. To recap, current APPL was based on 2017 US$/MYR exchange  rates of RM4.20-RM4.30 (vs RM4.60 currently) and drug prices back then. The group guided that the new prices will  be reflected in Jul 2023 onwards.

• Additionally, Duopharma will also enjoy an RM10mil reinvestment tax allowance in FY23F as plant K3 is expected  to start production in 2QFY23 onwards.

• Furthermore, the group guided that the prices of APIs are stabilising and should be moderating in the coming  quarters.

• This is consistent with Indian-based IIFL Securities’ (IIFL) API/KSM pricing index revealing that API import costs (mostly from China) have declined 2%-8% QoQ since 3Q2022. Typically, API accounts for 40% of medicinal cost. We  believe that this development could provide some buffer for the higher operating cost structure, which have already  been factored into our margin projections.
   
• Amid Pharmaniaga’s inventory impairment concerns, we understand that Duopharma has not faced any delayed  payments so far. Pharmaniaga accounted for 23%-27% of Duopharma’s sales in FY22.
   
• We continue to like Duopharma as the largest local pharmaceutical manufacturer which can leverage on several  favourable long-term trends: (a) the rising take-up of generic drugs in Malaysia, (b) upcoming industry’s patent cliff  in 2022-2026 and booming biosimilars with the company’s strength in R&D and state-of-art manufacturing facilities; and (c) ever-growing Vitamin C market with its popular brands, Champs and Flavettes.

• The stock currently trades at a compelling FY23F PE of 12.3x, which is 28% below the 5-year average of 17x. Dividend  yield is also decent at 2.4%.  

Source: AmInvest Research - 30 May 2023