Pharmaniaga’s 1H18 core earnings of RM34.5m (-5.7% QoQ, +12.5% YoY) was within expectations. YTD revenue improved 5.7% YoY on improved government orders. Indonesia returned to profit QoQ. Our forecast and TP remains unchanged. We upgrade to a BUY as valuations are near 2SD below 3 year mean accompanied by a dividend yield of 6.5% for FY18.

Within expectation. 1H18 turnover of RM1200.7m (5.7% YoY) translated into core PATAMI of RM34.5m (+12.8 % YoY), accounting for 56% of ours and 52% of streets estimates. We deem the results to be broadly in line as historically 1H represented 45%-57% of full year earnings. We can expect that the 3Q will be a seasonally weak quarter before a stronger finish in 4Q.

Dividend. Declared second interim dividend of 4.0 sen per share bringing YTD dividend to 9.0 sen per share (1H17: 8.0 sen per share). The interim dividend will go ex on 3rd September 2018.

QoQ: Revenue declined to RM 582.7m (-5.7% QoQ) on the back of lower sales to the concession in light of a seasonally weak 2Q, evident by the manufacturing segment incurring a loss of RM1m at the PBT level, whilst PBT margins shrunk (-6.5%) from the manufacturing due to a shift in product mix toward lower margin products QoQ. Consequently core PATAMI declined by 47.7% to RM11.8m attributable to lower operating leverage.

YoY: 2Q18 revenue grew to RM582.7m (+12.5% YoY) attributed to improved orders from government hospitals. EBITDA margin improved by 0.3 ppts to 5.6% on better cost management and the flow on effects of a stronger RM yoy. Subsequently, core PATAMI increased to RM11.8m (+7.9%).

YTD: 1H18 revenue improved to RM1200.7m (+5.7% YoY) due improved orders from the concession. EBITDA gained 6.3% to RM78.8m whilst margins inched marginally by 0.1 ppts to 6.6%. PATAMI declined by 15.9% due to a higher corporate tax rate of 40% (1H17: 23.5%) due to increased profitability of certain subsidiaries YoY. Core PATAMI improved 12.8% YoY after adding back write offs, provisions and forex amounting to RM10.5m.

Indonesia. MPI returned to the black QoQ, recording a PBT of RM1.58m (1Q17:- RM0.4m). YTD operating margins improved by 0.8 ppts to 2.5% (from 1.7% in 1H17) despite revenue declining by -6.6%. This improvement is attributed to better operating leverage despite the higher finance cost. It also embodies MPI’s better product mix in having more PT Errita products in its stable.

Forecast. Unchanged. Upgrade to a BUY and TP of RM.3.97. Our TP is based on FY19 earnings pegged to a P/E multiple of 15x. The stock warrants a relook at this level as it is trading near 2SD below 3-year historical mean or 11.8x P/E. Furthermore, we believe that at these levels the risk to upside ratio is attractive (upside of 34.2%). We are upgrading Pharmaniaga on the premise that it remains competitive and in pole position for a renewal in the concession due to their (i) expertise in L&D (ii) the margins from the concession business are not attractive (c.1%-2%) to attract other distributors (iii) it is highly unlikely that with the current financial position of the government they would undertake the necessary investments to return the drug distribution function back into public hands which will require immediate ramp up and <1% failure rate.

Source: Hong Leong Investment Bank Research - 20 Aug 2018