• Upgrade to BUY from Neutral with a higher MYR7.07 TP from MYR5.72, 12% upside and c.3% yield. We expect Kotra Industries to record a positive earnings growth momentum as a result of a potential revival in customer replenishment activities should raw material shortages from China worsen in 1H23 – the country may limit exports to cater for domestic demand. In view to this, we raise our FY23F-24F (Jun) earnings and roll forward our valuation to FY24F based on 15x P/E from 14x previously. Our TP incorporates 4% ESG premium.

• 2QFY23 results preview. We expect Kotra to continue delivering positive earnings growth in 2QFY23 – underpinned by healthy demand for over-the- counter or OTC medication from the local market and a recovery in export sales post border reopenings. That said, the potential impact of raw material shortages may not yet be reflected in the Dec 2022 quarter (2QFY23), but – on a QoQ basis – the company’s earnings growth is expected to taper off sequentially in 2QFY23 as customer replenishment activities should begin normalising. Nevertheless, should concerns over raw material shortages lead to frontloaded customer orders happening earlier than expected, we believe Kotra’s generic drug segment – ie Axcel and Vaxcel – will stand to benefit from the spike in orders from the healthcare services providers.

• Key beneficiary of a stronger USD. Despite the potential spike in active pharmaceutical ingredient or API costs, we expect Kotra to still have an edge in mitigating against the elevated raw material prices via its exposure to export sales (denominated in USD). Do note that the company’s export sales as a percentage of total revenue has recovered to 28% from 20% in 4QFY22 as a result of border reopenings in Apr 2022.

• Earnings estimate. We raise our FY23F-24F earnings by 10% and 8% to take into account a potential pick-up in order replenishments by its customers amid concerns over drug shortages.

• Valuation. We roll forward our valuation based on 15x FY24F P/E from 14x after taking into account the upside potential mentioned above. We also incorporate a 4% ESG premium to our intrinsic value to derive our TP, as Kotra’s ESG score stands above the country median.

• Key risks. Spikes in raw material prices, unfavourable drug pricing mechanisms imposed by the Government, and a depreciation of the MYR against USD are all key risks to our call.

Source: RHB Research - 6 Jan 2023