Concession renewability derailed. Quoting The Edgemarkets.com, Health Minister Datuk Seri Dr Dzulkefly Ahmad was quoted as saying that there would be no more concessions for logistics and distribution services for medical supplies, and an open tender system would be introduced instead. The latest news is a major blow to Pharmaniaga which concession expire end of this month. This means that Pharmaniaga will have to participate in open tender to secure the contract and may also have to contend with thinner profit margins due to competitive pressure. Separately, in an announcement to Bursa Malaysia, Phamaniaga stated that it is business as usual pending the Cabinet’s decision. The concession accounts for an estimated 50% of the group’s revenue.

History of the concession. The core earnings driver in Pharmaniaga lies in the Concession Agreement (CA) with the Ministry of Health (MOH) for the supply and distribution of pharmaceutical and medical products. The 10-year CA with the MOH which kicked off on 1 December 2009 was signed with the MOH in April 2011 encompasses the rights to store, supply and distribute approved drugs and medical products to Government hospitals. A significant element of the CA is the implementation of the Pharmacy Information System (PHIS) at 148 government hospitals and the Clinic Pharmacy System at over 1,200 clinics and district offices nationwide. PHIS will facilitate the management of pharmacy services across the board whereby Pharmaniaga will provide support and maintenance for the system. PHIS plays a vital and integral role in ensuring the distribution of drugs to patients and effective management of stock levels.

Outlook. The stock has been de-rated on the concerns of Government reviewing all medical supplies concession agreements of which Pharmaniaga has a 10-year contract ending in November 2019. However, we believe all is not lost for Pharmaniaga considering its track record, platform and systems already in place for the distributions of such medical supplies. Overseas, its Indonesia operation remains a key area of growth, while further progress is being made in the European Union as the Group seeks to expand its global presence. Over the longer term, we expect its manufacturing division to propel earnings growth. The group aims to add about 200 new products over the next 10 years to its existing portfolio of around 500 products.

Downgrade from MP to UP. We cut our FY20E net profit by 32% taking into account an 18% reduction in revenue. TP is cut from RM2.35 to RM1.60 based on unchanged 11x FY20E EPS (-1.5SD below 5-year historical forward mean). Downgrade from MP to UP.

Source: Kenanga Research - 1 Nov 2019