KOTRA’s 1HFY23 results beat expectations on stronger-than expected sales volume. We project FY23F-FY24F volume growth assumption of 16%-12% underpin by the growing trend of the population consuming health supplements for better defence against communicable diseases. We raise our FY23-24F net profit by 3-5%, our TP by 5% to RM7.35 (from RM7.00) and reiterate our OUTPERFORM call.

KOTRA’s 1HFY23 net profit of RM35m (+20% YoY) exceed expectations at 56% and 58% of our and consensus full-year forecast, respectively. The variance from our forecast was due to higher-than-expected sales volume. A 1st interim DPS of 10 sen was declared which came in above our expectation.

YoY, 1HFY23 revenue rose 20% due to higher sales volume. The group highlighted that there were major shortages of various prescription which drove sales. We believe there was a surge 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 margin fell slightly by 2% pts from 35% to 33% in 1HFY23 due to higher advertisement and promotional expenditure incurred for brand awareness. QoQ, 2QFY23 net profit fell 10% due to: (i) lower revenue (- 4%) and (ii) EBITDA margin falling to 32% from 33% in 1QFY23.

Outlook. Looking ahead, earnings are expected to be driven by (i) FY23F-FY24F volume growth assumption of 16%-12% underpin 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% fin FY23F/FY24F below the statutory rate due to unabsorbed business losses and unutilised reinvestment allowances. Amplifying the growth of the domestic OTC market going forward augers well for Kotra since its OTC segment makes up 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 FY23-24F net profit by 5% each as we raise our sales volume growth assumptions from 14-10% to 16-12%. Correspondingly, we raise our TP by 5% from RM7.00 to RM7.35 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, which could lead 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