Highlights

• The uninspiring FY16 earnings (RM52.9m, -40.3% YoY) largely reflected the government rationalizing its expenditure and shifting towards a leaner procurement model.

• We expect the trend of slower government offtakes to follow through in FY17 as evidenced by the 2017 Budget Healthcare allocation (RM4.0bn 2017 vs RM4.6bn 2016).

• Whilst the group has been working on a sleuth of measures aimed at diversifying its earnings base in the long run, which we are inherently positive on; its interim outlook still remains downcast by weaker demand from the concession business amidst a rising cost environment.

• To address immediate concerns, we expect Pharmaniaga to undergo an internal cost recalibration program in FY17 to address some of the margin pressures it faces amidst the slower concession off-take (Inventory optimization & efficiency drive in its logistics department).

• In the mid-term, we are upbeat on the prospects of Pharma’s venture into the Indonesian market, which augurs well for the group’s diversification strategy. Pharma’s 55% stake subsidiary PT MPI has 31 distribution points across Indonesia as at FY16 and is in a strong position to benefit from the nation’s increasing demand for medicines. To note, GlobalData estimate that the Indonesian Pharmaceutical industry is expected to grow to USD12.6bn in FY20 from USD7bn in FY15.

• Furthermore, PT Errita (manufacturing) is well positioned to benefit from the JKN initiative; a universal healthcare program which aims to provide 100% coverage to all Indonesian by 2019. This has fueled the demand for generic drugs in the nation. Indonesia accounted for 29% of non concession revenue in FY16 (FY15: 23%).

• However, the success of their Indonesian ventures largely hinges upon the successful registration of the right offerings into the JKN system having passed the drug registration hurdle and conquering the logistical challenge that Indonesia presents.

• We anticipate advancements into the private sector in FY17 on the back of the low base effect. The group has turned its attention to capture a greater share of the private business domestically amidst waning concession orders.

• Despite its Indonesia and private sector segments having shown positive signs, we anticipate the near term prospects to remain challenging for the bread and butter business, as lower concession orders (FY16: 51% of revenues vs. FY15: 56% of revenues) drag earnings.

Risks

• Downside risks to the stock stems from lower than expected government offtake and a further depreciation of the RM.

Forecasts

• Unchanged.

Rating

• Despite its monopoly in the government concession business, we expect near term headwinds driven by lower orders and higher finance cost to drag earnings. As such, we maintain our SELL rating on the stock.

Valuation

• Maintain TP of RM4.29 based on FY18 P/E multiple of 15.6x, at parity to international peers.

Source: Hong Leong Investment Bank Research - 13 Apr 2017