Hovid  sees  great  potential  in  the  coming  years.  It  recently  launched generic  versions  of  drugs  which  went  off  patent  2011.  An  estimated USD15bn  in  medicines  have  gone  off  patent  in  2013,  boosting  its potential  new  products  pipeline.  Plans  are  already  in  place  to  raise production  capacity  by  30%  in  2014.  We  value  the  stock  at  42  sen, pegged to 17x CY14F fully diluted EPS – an 18% upside.

• We hosted a corporate luncheon with Hovid for  our  clients in Dec 2013.    Management was represented by CFO and executive director  Mr Andrew  Goh.  Given  the  current  trend  of  patent  protection  expiry  for major “innovator drugs”,  management  was upbeat on Hovid’s prospects as a generic drug manufacturer. We concur with this view. The company is now ramping up capacity to capitalise on this trend.
• Tasty  takeaways  from  the  luncheon.  Among  the  notable  takeaways from  the  luncheon  were the fact that Hovid: i) recently launched  generic versions of two drugs whose patent protection recently expired  –  these medicines  generated  a  combined  USD9.7bn  annually  in  global  sales before  their  patents  ended,  and  ii)  is  working  on  a  further  six  generic versions of major  drugs  in 2014. Based on estimates,  there at  least  17 drugs  –  worth  USD15bn  in  total  global  sales  –  whose  patents  expired last year.
• 3-year (FY13-16) net profit CAGR of 21.9%.  Hovid plans to launch 10-12  new  products  annually  going  forward.  To  support  its  ambitions,  the company is: i) expanding capacity at its tablet and capsule plant this year with  a  planned  initial  “30%  increase”,  ii)  setting  up  its  own bioequivalence test centre for new generic drugs,  and iii) building  a new central warehouse to better manage the increase in inventory.
• MYR0.42  FV,  18% upside.  We value Hovid at 17x CY14F  fully diluted EPS,  a  discount  to  global  peers  average  of  18x  2014  earnings.  That said,  while  there  is  a  substantial  warrant  base,  we  do  not  think conversions  are  likely  at this juncture.  Pre-dilution,  Hovid’s  share  price would be 61 sen at 17x P/E. We like the company for its: i) 21.9% 3-year earnings  CAGR,  ii)  strong  exposure  to  the  export  market  –  ie  wellpositioned  to  benefit  from  further  USD/MYR  appreciation,  iii)  net  cash position, and iv) decent 15% ROE. This stock is Not Rated.

Industry Outlook
Tasty Luncheon Treats
Increasing trend of major drug patents expiring. We understand that generic drug manufacturers  worldwide  are  preparing  to  launch  their  own  versions  of  top-selling innovator drugs whose patents have expired/are expiring in 2011-2016. This  trend  is  driving  pharmaceutical  share  prices.  This  is  evident  in  mature generic  drug  manufacturing  hubs  like  India.  In  the  past  12  months,  selected  drug manufacturers  have  outperformed  the  benchmark  S&P  BSE  SENSEX  index  on anticipation of new product launches.

Luncheon  takeaway  No.  1  –  two  products  already  launched.  Among  major patents  that  expired in 2012,  it was  revealed  over lunch  that Hovid  launched  Plavix (an anti-clot or blood thinner that  prevents  heart attacks or strokes) and  Singulair  (an oral asthma and allergy treatment). Before their patents ended  in May and Aug 2012 respectively, both drugs together achieved worldwide sales of USD9.7bn per annum. Assuming Hovid is able to capture just 0.1% of existing sales – taking into account: i) competition from other manufacturers,  and ii) lower selling prices  –  this  will  translate into  MYR31.0m in new sales per annum  based on an exchange rate of MYR3.20  to USD1, or a 17% uplift to FY13 revenue from these two products alone.

Luncheon  takeaway  No. 2  –  six  new drugs coming  soon.  During the luncheon, management  also  shared  that  Hovid  has  a  further  six  products  either  under development  or  pending  registration  for  2014.  While  remaining  tight-lipped  on  the specific products, we understand that the company’s next few products  will focus on high demand  drugs required for longer-term treatments  like  diabetes, heart ailmentsand cholesterol, amongst others.

USD15bn  market  opening  up  in  2014?  We  gather  that,  of  the  estimated  17 innovator drugs whose patents expired in 2013, the top seven  best-selling drugs from this figure  generated c.USD14bn in sales  in  2012. We note too that all seven  were used in the treatment of long-term ailments.  The remaining 10, on the other hand, generated close to USD1bn in total.

Assuming  that  Hovid is able to launch just two of the lowest selling drugs, ie  Tricor and Niaspan, and capture just 0.1% of  the 2012 global sales figure, this will translate into MYR6.2m in new sales, or  equal to  3.6% of FY13 revenue. If  the company  is eyeing the two highest selling drugs, ie  Humalog  and  Cymbalta, this could generate MYR23.8m  in  sales  (based  on  the  assumptions  above),  or  up  to  13.5%  of  FY13 topline.

Background & Business Profile
Healing is Hovid’s heritage.  Hovid began in 1941  and was  founded by Dr Ho Kai Cheong with its initial  Ho Yan Hor  herbal  tea product, which  still  accounts for  up  to 5%  of  total  sales.  In  the  1980s,  Mr  David  Ho,  the  current  MD,  led  Hovid  into  the pharmaceutical manufacturing business.

Malaysian  pharmaceutical  export  leader.  Hovid  now  possesses  more  than  350 different  types  of  generic  drugs,  over  the  counter  (OTC)  medicines  and  dietary supplements  in  its product portfolio. It also  exports  its products  to over  45 countries, with exports  making  up 52.5% of FY13’s total sales. Of these exports,  the majority are Asia-centric (33.4%), while Africa (17.9%) is the new growth market.

We see this strong export success stemming from: i) Malaysia being a member of the Pharmaceutical Inspection Convention and Pharmaceutical Inspection Co-operation Scheme  (PIC/S),  and  ii)  Hovid  being  the  sole  Malaysian  supplier  to  the  United Nations  Children's  Fund  (UNICEF)  and  United  Nations  Relief  and  Works  Agency (UNRWA).

Locally,  Hovid’s  distribution channels cover private general practitioner  (GP)  clinics, pharmacies, hospitals and the Ministry of Health (MOH).  Domestic  sales  account for 47.5% of 2013’s total sales, of which only c.10% are to the MOH at present.

Generic Drugs

What are generic drugs? According to the US Food and Drug Administration (FDA), a generic drug is identical – or, in industry parlance,  bioequivalent – to a brand name drug in  terms of: i)  dosage form,  ii)  safety,  iii)  strength,  iv)  route of administration,  v) quality, vi) performance characteristics, and vii) intended use. Although generic drugs are  chemically  identical  to  their  branded  counterparts,  they  are  typically  sold  at substantial  discounts.  The  FDA  quotes  the  US  Congressional  Budget  Office  as stating that  generic drugs save US consumers an estimated  USD8-10bn  a year at retail pharmacies.

Are generic drugs as effective as brand-name drugs?  Yes. A generic drug is the same as a brand-name drug in  terms of  dosage, safety, strength, quality, the way it works, the way it is taken and the way it should be  used. The FDA requires generic drugs to have the same high quality, strength, purity and stability as their brand-name counterparts.

How are generic drugs cheaper? Creating a new drug costs a lot of money, as they must undergo: i) pre-clinical animal testing,  ii)  invitro  testing,  and iii)  clinical (human) trials  to establish safety and effectiveness.  Thus new drugs, like other new products, are  developed  under  patent  protection.  The  patent  protects  the  investment  in  the drug's development by giving the innovator company the sole right to sell the drug while the patent is in effect.

When the patent expires, other drug companies can start selling a generic version of this  medicine.  Since  generic drug makers  do  not  develop a  drug  from  scratch, the cost  to  bring  the  drug  to  market  is  less.  Therefore,  generic  drugs  are  usually  less expensive  than  brand-name  ones.  However,  generic  drug  makers  must  show  the FDA that their product performs in the same way as the brand-name drug.

How  are  generic  drugs  approved?  Drug  companies  must  submit  an  abbreviated new drug application (ANDA) for approval to market a generic product.  The ANDA process  does  not  require  the  drug  sponsor  to  repeat  costly  animal  and  clinical research  on  ingredients  or  dosage  forms  already  approved  fo r  safety  and effectiveness.  Instead generic applicants must demonstrate  via tests  that  show that their products are bioequivalent.

Source: RHB