KEY INVESTMENT HIGHLIGHTS

• Challenging but commendable 2QFY20 performance
• Remains committed to its L&D concession business and expecting improved margins going forward
• Still the frontrunner to Covid-19 vaccine fill and finish
• Embarking on a vaccine production path to sustain growth
• Indonesia division expected to stage a recovery in 1HFY21
• FY20-21F earnings estimate maintained
• Downgrade to NEUTRAL with a revised TP of RM4.74 per share

Commendable 2QFY20 performance recorded despite MCO. We attended Pharmaniaga’s 2QFY20 analyst briefing yesterday and came away feeling positive of the company’s future trajectory. Recall that, Pharmaniaga’s 2QFY20 and 1HFY20 earnings came in at RM9.9m and RM32.4m respectively which was commendable despite it being its seasonally weakest quarter. We understand that 2QFY20 was challenging due to the enforcement of the movement control order (MCO) which has not only restricted sales but also increases the logistics costs during the period by +RM3.0m during the quarter. That said, its logistics and distribution (L&D) segment was operating at full capacity as it was deemed as an essential service whilst its manufacturing segment was operating at 50% capacity during the MCO.

Logistics & Distribution (L&D) to remain as Pharmaniaga’s backbone. While there is limited visibility at this juncture on the extension of the concession agreement beyond the current extension which is due to expire in November 2024 however; Pharmaniaga reiterated its stance that it will remain committed in providing its L&D services to the Ministry of Health as it has both the capacity and the logistics network required for the job. Additionally, going forward Pharmaniaga aspires to supply more products that falls under the Approved Product Purchase List (APPL) provided by the MOH which will in turn is expected to lift its margins overtime. Recall that, its PBT margin as at 1HFY20 was recorded at 2.2% vs 2.0% in 1HFY19.

Covid-19 vaccine fill and finish frontrunner. While not much information is available at this juncture with regards to the fill and finish tender for the Covid-19 vaccine, we understand that Pharmaniaga is one of the frontrunners to win the tender. This is due to the fact that Pharmaniaga has a: (i) well-established logistics and distribution network nationwide and; (ii) large capacity of sterile and liquid plant to conduct the fill and finish process for the vaccine. Currently, Pharmaniaga’s small volume injectable (SVI) plant located in Puchong has the capacity to produce 10.0m doses per month.

We understand that to undertake the fill and finish process for the vaccine, Pharmaniaga will require a small CAPEX investment of RM2.0m which will be spent towards retrofitting its existing SVI plant. The retrofitting will take a month to complete which would also include putting in place new machineries. While there is no information on the financial impact on Pharmaniaga if it were to land the tender, the volume is expected to be quite substantial. We were made to understand that at a bare minimum, the vaccine needs to prepared for 20% of the Malaysian population that belongs to the vulnerable group i.e: those aged >60 years old and frontliners which makes up about 7.0m of the population. This translates to about 21.0m doses required to be prepared as the vaccine will require dual or triple doses to complete an immunisation program.

Vaccine production as potential growth driver. Additionally, Management also disclosed during the briefing that it intends to embark on producing vaccines in the coming years. The company envisages producing all the 12 vaccines that are currently listed under the National Immunisation Program in the future and currently in the midst of constructing the plant will be dedicated to the vaccine program. It is estimated to cost Pharmaniaga a CAPEX of RM100.0m within the next two years.

Indonesia division to stage a recovery in 1HFY21. Recall that, Pharmaniaga’s Indonesian division registered a lower revenue by -11.0%yoy during the quarter attributable to the limited access to healthcare facilities in Indonesia following the implementation of its Pembatasan Sosial Berskala Besar (PSBB). Consequently, the division reported a -54.6% decline year-over-year at the EBIT level due to the delay in payment by government hospitals in Indonesia which is currently affecting the healthcare industry in that country. We understand that this was as a result of inadequate premiums paid to the insurer which were not enough to cover the payment for the pharmaceutical products procured by the Government hospitals. This was further exacerbated by the high cost of borrowings in Indonesia (~10%p.a) which hit Pharmaniaga during the year with limited revenue recognition.

That said, Indonesia remains as a growth area for Pharmaniaga as the division grew by +14.0% in FY19 – higher than its industry average growth of upper single digit. It is also expecting to improve its margins in Indonesia as it has cease from distributing other producers’ products – which has resulted in lower margin for its Indonesia division previously. Going forward, it will be concentrating on selling its own products in Indonesia manufactured by its plant PT Errita in Bandung and from Malaysia. Furthermore, the payment issue it’s currently experiencing is expected to be resolved within the first half of FY21.

Impact to earnings. We made no changes to our FY20-21F earnings estimates at this juncture as we opine that all positives have been priced in.

Target price. We are making no changes our target price of RM4.74 per share. Our target price is derived via pegging our FY21F EPS of 31.6sen to a revised target PER of 15.0x which is the average of its historical five-year rolling PER.

Downgrade to NEUTRAL with POSITIVE BIAS. All things considered, we are downgrading our recommendation on Pharmaniaga to a NEUTRAL (from Buy previously) as all positives have been priced in at this juncture and details on the Covid-19 vaccine’s fill and finish tender remains scarce. Furthermore, its future growth plan will take at least five years to bear fruit which we opine will limit earnings appreciation in the medium term. That said, we have a POSITIVE BIAS on the Pharmaniaga given that the company remains as the few beneficiary in the current global Covid19 pandemic crisis.

In this regard, Pharmaniaga is well-positioned to benefit from this as it among the few industry players that have the capability to manufacture as well as; distribute medical drugs and pharmaceutical products nationwide owing to its extensive network of logistics. Additionally, while it remains an attractive stock to accumulate with a decent FY21F dividend yield of 3.3% given its positive industry-wide growth prospect; its share price has surged by >180.0%ytd since February which we opine will limit the share price appreciation potential going forward.

Source: MIDF Research - 25 Aug 2020