Investment Highlights

• We reiterate BUY on Duopharma Biotech (Duopharma) with a lower fair value (FV) of RM1.78/share (from RM2.06/share previously) after accounting for lower earnings forecasts. The FV is based on a rolled-forward FY24F target PE of 17x, at parity to its 5-year average. There is no ESG-related adjustment based on our neutral 3-star rating.

• Duopharma’s 1HFY23 core net profit of RM40mil generally came below expectations, accounting for 37% of our FY23F forecast and 41% of the street’s. As a comparison, 1H accounted for 46%-53% of FY18-22 core net profit. The deviation was mainly attributed to lower-than-expected revenue from ethical classic and specialty segments, coupled with lack of pricing power to pass on higher operating costs in 2QFY23.

• Hence, we cut FY23F/24F/25F earnings by 14%/19%/18% with lower sales growth assumptions, especially in the domestic market and lower core gross profit margin (GPM) assumptions. Our FY23F net profit has factored in potential tax savings of RM10mil in 2HFY23F upon the commissioning of plant K3 in 2QFY23.

• The group declared its first interim dividend of 0.5 sen/share in 2QFY23 (implying a payout of 34%), which came in below our earlier forecast of 3.4 sen/share given Duopharma’s weaker-than-expected 1HFY23 core earnings.

• On a YoY basis, Duopharma’s 2QFY23 revenue decreased by 8% to RM168mil, primarily due to lower sales of discretionary consumer healthcare (CHC) products - Flavettes, Champs and Proviton.

• We believe this was due to destocking by consumers after robust purchases in FY20-21, as well as decline in consumer sentiments as a result of declining economic growth and higher living costs. Notably, CHC contributed 20% of Duopharma's revenue in FY22.

• The lower sales caused 2QFY23 core earnings to halve YoY to RM14mil. The lower core earnings were further impacted by lower core GPM (-4ppt) that was eroded by higher electricity tariffs, labour costs, finance costs and costs incurred due to temporary shutdown of a small volume injectable plant for upgrading and maintenance, coupled with incremental costs (RM5mil in FY23F) from the commencement of production in the new K3 facility.

• We no longer assume Duopharma’s core GPM could normalise in 2HFY23F by raising product selling prices to pass on higher operating costs, as lower-than-anticipated revenue in 2QFY23 implies that demand is insufficient for the group to effectively hike product prices.

• In addition, Duopharma has not announced any renewals of the approved products purchase list (APPL), for which the tender (60%-80% of total medicinal items) has been open since April 2023. According to management, the contract should have been awarded by the end of June 2023. We view this delay negatively, which could disrupt Duopharma’s pricing strategy. To recap, the group intended to revise prices in July 2023 after being awarded APPL renewals in June.

• On a QoQ basis, Duopharma’s 2QFY23 revenue dropped 16%, mainly dragged by ethical classic and specialty segments following material restocking activities from the Ministry of Health (MoH) in 1QFY23, after lower year-end orders in 4QFY22. 4Q is typically MoH’s account closing period.

• This caused the group’s 2QFY23 core earnings to halve QoQ, which was further exacerbated by higher operating costs bringing core GPM to deteriorate by 3ppt.

• Nevertheless, we believe Duopharma could benefit from the continued return of patients to hospitals (Exhibit 2) and higher government allocation to MoH in 2023F amounting to RM36.3bil (+12% YoY vs. 10-year CAGR of 7%) in 2HFY23F.

• In view of recent share price correction prior to the lower-than-expected 2QFY23 result, we believe the stock has overreacted as it now trades at a compelling FY24F PE of 11x – 33% discount to its 5-year average of 17x while offering a decent dividend yield of 2.6%.

Source: AmInvest Research - 25 Aug 2023