• We initiate coverage on Kotra Industries with BUY, TP of MYR5.72 offers 19% upside with a c.4% FY23F (Jun) dividend yield. We like Kotra for its robust earnings quality, strong recognition of its flagship over-the- counter (OTC) brand of pharmaceutical products (Appeton), attractive yields vs that of peers, and it being a beneficiary of a stronger USD. We expect the company to book a revenue CAGR of 9% over FY23-25F, premised on resilient demand for its nutraceutical products and the gradual pick-up in export sales. Our TP has a 4% ESG premium built in.

• Superior earnings quality. Kotra has recorded an impressive FY19-22 earnings CAGR of 39%, in spite of the various macroeconomic challenges related to the pandemic as well as issues regarding labour shortages. Its success story is built on the strong and longstanding reputation of the Appeton brand, which enjoys strong recognition among Generation X and Generation Y consumers. Its growth also coincided with the increase in healthcare spending per capita – at MYR2,057 in 2020 vs MYR1,331 2010, according to the Ministry of Health (MOH) – as well as health awareness among consumer seeking to improve immunity against COVID-19 and other non-communicable diseases (NCD).

• Key beneficiary of a stronger USD. Over 29% of its FY22 total sales are for exports – mainly to ASEAN countries and Africa. As export sales are denominated in USD terms, this enables it to capitalise on the strengthening USD. We also see further room for growth, from exports recovering to pre- pandemic levels (accounting for c.40-45% of total revenue) following the reopening of country borders and stock replenishing by customers. A 10% appreciation in the USD would boost earnings by 2%.

• Attractive yields. Kotra has been in a net cash position for three consecutive years, after raising its paid-up capital in FY19. Its dividend payout ratio has increased to 61% for FY22, representing a 5.3% yield. We expect dividends to normalise to pre-pandemic levels in FY23, ie at c.50% of earnings, as capex is set to rise due to a warehouse expansion. This would imply c.4% yields for the medium term.

• Valuation. Our TP of MYR5.72 is based on 14x FY23F P/E, to reflect the expected recovery of its export sales, as well as the pick-up in OTC supplementary product sales as health awareness continues to grow post pandemic. The stock is trading at 13.1x forward P/E, at 1.2SD above its historical mean of 10x. At the current valuation, Kotra is trading at a 13% discount from the sector’s P/E mean of 15x (Figure 11). We believe Kotra is undervalued, given its proven track record, established brand in the local market and net cash position. Our TP includes a 4% ESG premium, since its ESG rating is two notches above the country median.

Source: RHB Research - 4 Nov 2022