Investment Highlights

• We reiterate BUY on Duopharma Biotech (Duopharma) with a lower fair value (FV) of RM1.69/share (from RM1.78/share) to account for a lower FY24F EPS based on an unchanged target PE of 17x, at parity to its 5-year average. There is no ESGrelated adjustment based on our 3-star rating.

• After an analyst briefing yesterday, we reduced FY23F-25F earnings by 16%/5%/5% mainly to account for weaker 2HFY23F sales vs. 1HFY23 and a lower FY23F core gross profit margin from 42% to 40% due to the temporary shift in procurement process by the government from an approved products purchase list (APPL), which offers a guaranteed level of orders, to buying on a need basis following the APPL expiry in end-Jun 2023.

• Our FY23F net profit has factored in potential tax savings of RM10mil in 2HFY23F upon the commissioning of plant K3 in 2QFY23. These are the salient highlights from the analyst briefing:

• Duopharma clarified that lower-than-expected revenue from ethical classic and specialty segments in 2QFY23 was mainly due to weaker demand from the public sector (-13% YoY).

• Based on market intelligence, hospitals under the Ministry of Health (MoH) are more cautious in procurement and distribution of drugs in 2QFY23, despite 2023F government allocation to MoH rising to RM36.3bil (+12% YoY vs 10-yr CAGR of 7%).

• Recall that Pharmaniaga was classified as a PN17 company due to its negative equity position in late Feb 2023. This led us to believe that Pharmaniaga's financial distress disrupted significant orders from Duopharma, contributing to MoH's soft demand in 2QFY23. Duopharma indicated that the company has not yet experienced any payment delays from Pharmaniaga.

• Surprisingly, Duopharma disclosed that the APPL expired at the end-June 2023 with no renewal in sight yet in FY23 from the government. This is unprecedented for the pharmaceutical industry.

• Without an APPL which provides an assured takeup level to suppliers, MoH has been purchasing on a need basis. We view this negatively as: (1) it implies that MoH's sales volume will be lower in 2HFY23 than 1HFY23, and (2) disrupted Duopharma's pricing strategy to pass on higher operating costs. To recap, the group originally intended to revise prices in July 2023 if it had been awarded APPL renewals in June.

• On a positive note, the group reported that the tendering of a new APPL contract with MoH has started. The award and supply of drugs to MoH under a new contract are expected to be concluded by 1QFY24. The new APPL will have a volume increase of 3% to 5% over its predecessor, while the pricing will be comparable or slightly higher.

• Separately, the group guided that its consumer healthcare (CHC) segment could stabilise in 2HFY23F and regain growth momentum in FY24F. All in, we believe Duopharma will have an unexciting 2HFY23F earnings trajectory albeit a stronger FY24F.

• 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 FY24F PE of 11.5x, which is 32% below the 5-year average of 17x. Dividend yield is also decent at 2.6%.

Source: AmInvest Research - 15 Sept 2023