KOTRA’s 1HFY23 results beat expectations as consumers took precautionary steps amidst rising cases of the common flu and influenza-like illnesses by stocking up health supplements. We raise our FY23F net profit by 3% but keep our FY24F numbers. We maintain our TP at RM7.00 (based on FY24F earnings) and reiterate our OUTPERFORM call.

1HFY23 net profit of RM35m exceeded expectations, coming in at 56% and 58% of our full-year forecast and the full-year consensus estimate, respectively. The variance against our forecast came largely from strong sales as consumers stocked up health supplements. A first interim DPS of 10.0 sen was declared which was a pleasant surprise.

YoY, 1HFY23 revenue rose 22%, we believe, driven by an increase in demand for health supplement products as consumers take precautionary steps amidst rising cases of the common flu and influenza-like illnesses (following increased contacts within the population after the lifting of pandemic restrictions). EBITDA only rose by 15% on increased advertising and promotional expenses to widen its brand awareness.

QoQ, 2QFY23 revenue fell 4%. We are unperturbed and regard this as nothing more than a normal quarterly fluctuation and take comfort that 2QFY23 revenue actually rose a whopping 18% YoY. 2QFY23 fell by a steeper 10% due to higher advertising and promotional expenses amidst the year-end shopping season.

Outlook. Looking ahead, earnings are expected to be driven by: (i) FY23F and FY24F volume growth assumption of 16% and 12%, respectively, underpinned by the growing trend of the population consuming health supplements for better defence against communicable diseases, (ii) sustainable EBITDA margin of 34%-35% due to economies of scale and better overhead absorption rate thanks to incremental sales, (iii) an effective tax rate of 8%-10% in FY23 and FY24, below the statutory rate due to unabsorbed business losses and unutilised reinvestment allowances. Amplifying the growth of the domestic OTC market going forward augurs well for Kotra since its OTC segment makes up more than half of revenue, i.e. 53% of FY22 revenue.

We expect Kotra to capitalise on rising out-of-pocket health expenditure to pharmacies. Case in point, out-of-pocket healthcare spending in Malaysia to private pharmacies (Kotra’s OTC products accounts for 50% of its FY22 revenue) delivered a 10-year CAGR of 11%.

Forecasts. We raise our FY23F net profit by 3% as we raise our sales volume growth assumptions from 14% to 16%. However, we keep our FY24F earning unchanged. Our TP remains unchanged at RM7.00 based on 15x FY24F EPS, in line with its peers’ average. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 3).

Maintain OUTPERFORM. We like KOTRA for: (i) the bright prospects of the over-the-counter (OTC) drug market, (ii) its integrated business model encompassing the entire spectrum of the pharmaceutical value chain from R&D, product conceptualisation to manufacturing and sales, (ii) the superior margins of its original brand manufacturing (OBM) business model (vs. low-margin contract manufacturing) with established household brands such as Appeton.

Key risks to our recommendation: (i) failure in clinical trials could scupper new-product break-through, leading to the inability to recover cost incurred for the pre-clinical and clinical trials, (ii) its dependency on commercialisation of new products and slower-than-expected commercial operation of the new lab to generate new revenue stream in the future.

Source: Kenanga Research - 27 Feb 2023