Pharmaniaga’s 2Q22 core PATAMI of 7.8m (-74.8% QoQ, -57.9% YoY) brought 1H22 core PATAMI to RM38.8m (-13.8% YoY). Performance was below both our and consensus projections, at 42% and 35% respectively. The negative surprise was due higher-than-expected costs, as the Group mainly incurred additional A&P costs to boost brand recognition of its OTC and consumer healthcare products. We lower our earnings forecast for FY22-24f by 15-26% as we impute higher A&P and staff cost into our assumptions. Following our earnings cut and rolling over of valuation base year, our TP is lowered to RM0.63 (from RM0.83 previously), based on a P/E valuation of 11.6x. While we acknowledge that additional spend on A&P is essential to grow Pharmaniaga’s private sector sales, we also opine that this will adversely impact margins in the short to medium term. With that, we downgrade Pharmaniaga to HOLD.

Missing estimates. Pharmaniaga’s 2Q22 core PATAMI of 7.8m (-74.8% QoQ, -57.9% YoY) brought 1H22 core PATAMI to RM38.8m (-13.8% YoY). The weaker performance came in below both our and consensus forecasts, and the discrepancies to our projections were due to higher-than-expected costs. 1H22 core PATAMI was arrived at after adjusting for EIs (mainly provision for stock obsolescence) amounting to RM10m.

Dividend. Declared dividend of 0.5 sen per share, going ex on 9 Sept 2022. (1H22: 1.3 sen). 2Q21: 1.5 sen (1H21: 2.3 sen)

QoQ. Weaker showing at its logistics and distribution segment (L&D), down 24.4%, has resulted in the overall Group revenue declining by 20.9%. The weaker revenue contribution from L&D segment in 2Q was due to the cyclical nature of its concession business, whereby the Group saw stronger stocking up activities by the government in 1Q. Core PATAMI suffered a sharper decline of 74.8% due to higher staff cost and advertising and promotion (A&P) cost incurred.

YoY. Revenue moderated by 35.3% due to higher base in 2Q21 from the sale of Sinovac vaccines. Revenue was also impacted by the lower sales from its non concession segment, owing to the timing of MoH orders. Core PATAMI fell 57.9% due to increasing operating cost and financing cost. The increase in finance cost was a result of higher borrowings and increasing interest rates.

YTD. Despite recording growth across all of its key segments (concession business, private sector and Indonesia operations), revenue was still 12.6% lower, due to the absence of one-off significant revenue contribution from Covid-19 vaccine sales. In turn, core PATAMI fell by 13.8%, due to increased operating expenses (staff costs and A&P costs).

Outlook. In an attempt to boost private sector sales in both Indonesia and Malaysia, Pharmaniaga has set up a marketing team in both the markets, which resulted in higher staff costs. The recruitment process began in 1Q22 and the exercise is close to completion as at 2Q22. Pharmaniaga will also continue to invest in A&P spending to improve brand recognition for its OTC and consumer healthcare brands. We note in 1H22, the Group has spent a total c.RM12m in A&P. On a separate note, Pharmaniaga will also be meeting with the Islamic Development Bank (IDB) to discuss on the potential supply of Covid-19 vaccines to several Organization of Islamic Cooperation (OIC) countries. IDB has set aside a budget USD800m for this purpose.

Forecast. We lower our earnings forecast for FY22-24f by 15-26% as we impute higher staff costs and higher A&P cost into our assumptions.

Downgrade to HOLD, TP: RM0.63. Although we acknowledge that additional spending on A&P is essential for Pharmaniaga to boost the brand recognition of their consumer healthcare and OTC products, we are of the view that, in the short to medium term, increased A&P spending would adversely impact the Group’s margins. Subsequent to our earnings cut and rolling over of valuation base year to FY23f, our TP is lowered to RM0.63 (from RM0.83 previously). TP represents a P/E multiple of 11.6x (at +0.5SD of its 5-year mean). Given limited upside, we downgrade our rating on Pharmaniaga to HOLD.

Source: Hong Leong Investment Bank Research - 22 Aug 2022