We attended Pharmaniaga’s briefing and came back feeling more optimistic on the stock. Pharmaniaga won’t be burdened by PhIS amortisation moving forward and this is expected to lift earnings. We adjusted our forecasts to account for this. Given the 5 year concession extension granted by MOH, and the absence of PhIS amortisation going forward, we are upgrading the stock as we feel that at these valuations, the risk reward is favourable. We raise our PE target to 13x (-0.5SD below 5 year mean) (from 12x), tagged to FY20 EPS. Thus we upgrade to a BUY (from HOLD), with higher TP of RM2.30 (from RM2.08).

We Attended Pharmaniaga’s Briefing and the Following Are Some Key Take Aways:

No more amortisation on PhIS. To recap, the Pharmacy Information System (PhIS) is a system developed and managed by Pharmaniaga for MOH as part of the contractual obligations under the Concession Agreement (which concluded November 2019). The government has extended Pharmaniaga’s services for the provision of medicines and medical supplies to MOH until 2021 and also awarded new contract to continue providing logistics and distribution services for MOH to over 148 government hospitals and 1,300 government health centres nationwide till 2024. Following the new contract arrangement, the remaining unamortised PhIS costs was fully recognised in 4Q19. Moving forward, there will be no more amortisation charges for the PhIS, thus positively impacting earnings.

Ranitidine recall. Back in October 2019, MOH recalled 10 drugs containing the active ingredient ranitidine (found to contain impurity above the permitted level) that is commonly used to treat stomach ulcer. Pharmaniaga was affected by this in both manufacturing and logistics business; therefore there was a provision for stock write off on the Ranitidine product recall of RM9m in 4Q19. Management expects no further provisions relating to this matter.

New venture. Pharmaniaga is looking to venture into newer markets such as Europe and other Southeast Asian countries. To date, Pharmaniaga has registered 2 products in Portugal and it is in the process of registering them in other countries. Normally the R&D of a product would take about 3 years and the registration process will take about 2 years before the products can be marketed. Pharmaniaga has almost 200 products in plan to be roll out in the next 10 years.

Succession plan on track. Managing Director, Dato’ Farshila Emran will be leaving Pharmaniaga when her contract expires in end March 2020. Following her departure, COO, En. Mohamed Iqbal Abdul Rahman will be the acting MD. Pharmaniaga assured that the succession plan is on track while focusing more on improving manufacturing efficiency.

Forecast. We tweak our forecasts to account for the absence of PhIS amortisation going forward. We are also reducing some margin assumption (c.0.5ppts) for their manufacturing division as we expect lower take up from the government. On an net basis, FY20-21 earnings increases by 5%-4%.

Upgrade to BUY, TP: RM2.30. Given the 5 year concession extension granted by MOH, and the absence of PhIS amortisation going forward, we have a positive tilt on Pharmaniaga. Coupled with the share price decline (-20% since late October 2019), and at these valuations (10.5x of our FY20 EPS or at -1.5SD below 5 year mean) the risk to reward seems favourable. We raise our PE target to 13x (-0.5SD below 5 year mean) (from 12x), thus our TP increase to RM2.30 (from RM2.08). We upgrade to a BUY (from Hold).

Source: Hong Leong Investment Bank Research - 24 Feb 2020