Investment Highlights

• Downgrade the healthcare sector to Neutral from Overweight previously as we believe that market interest could be muted in the near future due to unexciting 2HFY23F results for hospitals and pharmaceutical players following disappointing 2Q2023 results. For hospital operators, we expect IHH Healthcare (IHH) to have flattish sequential core earnings in 2HFY23F given higher finance costs (+2.1x YoY) in 2QFY23 despite total financing remaining at RM9.3bil-9.4bil. IHH guided that this was a result of recent interest rate revisions in tandem with global trends. In terms of valuation, the stock currently trades at a fair FY24F P/BV of 1.7x, which represents a 13% discount to its 5-year average of 2.0x amid slowing global economic growth prospects. Nevertheless, IHH will continue to ride on post-pandemic 3-year growth (2023-2025) strategies by expanding bed capacity across Malaysia (+600 beds from 2.8K currently), India (+1.4K beds from 5K), Turkey and Europe (+580 beds from 3.4K), while exploring strategic opportunities across Asia and Europe (Exhibit 2).
  For pharmaceuticals, Duopharma Biotech (Duopharma) guided for a weaker 2HFY23F compared to 1HFY23 as a result of the temporary shift in procurement process by Ministry of Health (MoH) 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. For Apex Healthcare (Apex), management adhered to the guidance presented in Feb 2023 results briefings onwards, stating that demand for their pharmaceutical products in 2HFY23F will be weaker than 1HFY23. This stems from delayed spending on discretionary consumer healthcare products and Malaysian flu cases being relatively lower in Jul and Aug 2023 compared to Jan and Feb 2023 (Exhibit 3), potentially reducing demand for flu-related medications. Nevertheless, Duopharma (BUY, FV: RM1.69/share) remains our top pick.

• APPL’s expiration was a negative surprise. Duopharma disclosed in a recent analyst briefing that the APPL which expired on 30 June 2023 does not have a renewal in sight yet in 2HFY23F from the government. This is unprecedented for the pharmaceutical industry. Without the APPL, which offers a guaranteed level of orders to suppliers, MoH has been purchasing on a need basis. We view this negatively as it: (1) 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, consequently, core gross profit margin in 2HFY23F will be less favourable than 1QFY23 albeit comparable to 2QFY23. To recap, the group originally intended to revise prices in July 2023 for the APPL segment, which accounts for 20%-25% of Duopharma’s 1HFY23 group sales, if the APPL was renewed in June.
  On a positive note, the group anticipates that the award and supply of drugs to MoH under a new APPL contract could be concluded by 1QFY24. The new APPL is expected to have a volume increase of 3%-5% over the former list, while pricing will be comparable or slightly higher.

• Malaysian flu cases in 2H2023 could be lower than 1H2023. According to data from the World Health Organisation (WHO), the number of influenza (flu) cases in Malaysia has been volatile since late 2021 and peaked in mid-Jan 2023 (Exhibit 3). Despite recent increase in the flu cases in mid-Jun 2023, we estimate that average weekly flu cases in Jul-Aug 2023 of 195 were 24% lower than 257 cases in Jan-Feb 2023. This could imply that demand for Apex’s flu-related medications (cough syrups, analgesics and throat lozenges) will be weaker sequentially in 2HFY23F, consistent with guidance provided by management since the Feb 2023 result briefings.

• Decline in API prices is no longer a boon to pharmaceuticals. India-based IIFL Securities’ (IIFL) API/KSM pricing Index, which composed of 16 key imported pharmaceutical products from China, has shown consistent declines in active pharmaceutical ingredients (APIs) costs over the past 4 quarters i.e., 1%-13% QoQ contraction since 3Q2022 mainly due to easing of supply chain disruptions and transportation costs. This was after a 3%-8% sequential API cost increase in 1Q2021 to 2Q2022. Typically, APIs account for 40% of medicinal cost. In our previous sector report published in Jul 2023, we opined that the continuing moderation in APIs costs will be crucial to provide potential margin tailwinds for Apex and support Duopharma’s core GPM of 43% in FY23F, under the assumption that they can increase product prices in 2HFY23F. However, we now view that the lower API prices could only partially offset higher operating costs (ie. electricity tariff and entitlement threshold for overtime work) in 2HFY23F, given that pricing leverage of both pharmaceutical players may not be as optimistic as initially anticipated amid weakening demand and expiry of APPL.

• Credit risk from Pharmaniaga to Duopharma is overpriced. Notably, Duopharma’s share price declined since late Feb 2023, coinciding with Pharmaniaga’s announcement of its PN17 status. We believe that the market was pricing in Pharmaniaga’s credit risk on top of a disappointing 2QFY23 result, given that the group accounted for 23%-27% of Duopharma’s FY22 sales. Based on recent checks with management, we understand that Pharmaniaga has fulfilled all obligations for now. Also, Duopharma has increased the frequency of collection since May as credit risk management measures.

Source: AmInvest Research - 19 Sept 2023