• D/G to NEUTRAL from Buy, unchanged MYR5.72 TP, 5% upside and c.4% yield. Kotra Industries’ 1QFY23 (Jun) earnings came in above our and Street’s expectations on the back of a surge in demand for over-the- counter (OTC) medication from the local market (+38% YoY), as well as higher sales to export markets. Current valuation is fair at 13.8x CY23F P/E on the back of a normalised earnings outlook. We downgrade to NEUTRAL based on CY23F P/E of 14x.

• 1QFY23 results overview. Kotra’s 1QFY23 core earnings came in at MYR19.5m (+33% QoQ, +36% YoY), accounting for 35% and 36% of our and Street’s full-year estimates. The stronger-than-expected sales were mainly driven by a surge in demand for OTC medication from the local market (+38% YoY) and higher sales in export markets (+5% YoY) as a result of easing supply chain constraints. On a sequential basis, Kotra reported 33% QoQ revenue growth due to robust demand for medication in the local market. Export sales surged 91% QoQ as there was a delay in the issuance of import permits from overseas markets in 4QFY22. The group did not declare any dividends for the quarter.

• 1QFY23 operating margin expanded 2.9ppts QoQ and 13.5ppts YoY to 28.4%, helped by better operating efficiencies and robust topline growth – offset by higher advertisement and promotional expenditure incurred for brand awareness. Kotra resumed its advertisement spending during the quarter (predominantly in the export markets) as its previous advertising plan was halted during the lockdown. Operating expenses stood at a favourable level, accounting for 75% of the group’s total revenue – a slight pick-up from 72% in 1QFY22. We believe the increase was from a spike in an active pharmaceutical ingredient (API) due to the strengthening of the USD against the MYR. We think Kotra still has an edge in mitigating against elevated raw material prices via its exposure to export sales (USD- denominated) which grew to 28% of 1QFY23 revenue from 20% in 4QFY22.

• Our earnings estimates are unchanged as we expect Kotra’s results to taper off moving into 2HFY23, following the normalisation of medicine restocking activities.

• Valuation. Following our initiation, Kotra has surged c.10%, and we deem the current valuation as fair (13.8x CY23F P/E) on the back of a normalised earnings outlook. We downgrade to NEUTRAL based 14x CY23F P/E, and incorporate a 4% ESG premium to our intrinsic value to derive our TP, as Kotra’s ESG score is above the country median. Key downside risks: Spike in raw material prices, unfavourable drug pricing mechanism imposed by the Government, and the depreciation of the MYR vs USD.

Source: RHB Research - 30 Nov 2022