KEY INVESTMENT HIGHLIGHTS

• 9MFY19 earnings came in at RM29.4m (-22.7%yoy), which lagged ours and consensus expectations

• Earnings was negatively impacted by one-off expense and higher amortisation costs

• Expect an accelerated amortisation going forward

• Downgrade to NEUTRAL with a revised TP of RM2.27 per share

Earnings lagged expectations. Pharmaniaga’s 3QFY19 earnings came in at RM0.5m (from RM15.1m in 3QFY18). This brings its cumulative 9MFY19 earnings to RM29.4m which lagged ours and consensus earnings estimates at 59.8% and 54.8% respectively.

Strong sales recorded during the quarter. Pharmaniaga reported encouraging 3QFY19 sales growth of +22.0%yoy to RM716.8m. This is driven by the logistics and distribution (L&D) division where revenue grew by +27.4%yoy to RM514.0m. However, overall earnings was partly dragged by one-off expenses related to staff remuneration amounted to RM10.0m which we believe is an ex gratia. This has resulted in the dropped in profit margin to 0.1% (from 2.6% in 3QFY18).

Expect higher amortisation from 4QFY19 onwards. The management indicate that there will be a higher amortisation of Pharmacy Hospital Information System (PHIS). Previously, it was expected that the L&D services to the government will be continued for another 10 years upon expiry. Due to the shorter than expected contract period awarded to Pharmaniaga of only five-year, we estimate that the amortisation rate of PHIS will doubled to about RM10.0m quarterly and RM40.0m annually for the next five years from 4QFY19 onwards.

Stronger cash flow position. The group’s operating cash flow has turned positive at RM12.1m in Q3FY19 (from –RM245.3m in Q3FY18) due to the higher sales recorded and improved collection. In addition, as amortisation is a non-cash item, we expect improvement in the cash position to continue moving forward.

Impact to earnings. We are revising our FY19F, FY20F and FY21F earnings forecast downwards by -29%/-23%/-21% to take into account the: (i) one-off operating expenses and; (ii) higher amortisation rate.

Target price. We are revising our target price to RM2.27 (previously RM2.95) per share. This is premised on pegging revised FY20F EPS of 16.2sen to target PER of 14.0x which is the average of its historical twoyear rolling PER.

Downgrade to NEUTRAL. Pharmaniaga’s 10-year concession agreement with the government is slated to expire by the end of this month. Nevertheless, due to its vital role in ensuring timely supply of medicine is to over 148 government hospitals and 1,700 clinics nationwide, the government has extended the current contract which end in FY21 and provided them with a new contract until the end of FY24. Nonetheless, this has an impact on amortisation rate of PHIS as it was amortised previously based on a 10-year period. With a shorter new five year contract, the amortisation of this intangible asset will be accelerated from 4QFY19 onwards and put a drag on earnings. However, we expect strong sales growth from concession and non-concession businesses will contribute to improve Pharmaniaga’s cash position going forward. Due to this, the stock commands an attractive dividend of more than six percent in comparison with its peers. All things considered, we downgrading our stock recommendation to NEUTRAL from buy previously.

Source: MIDF Research - 21 Nov 2019