• Downgrade to NEUTRAL from Buy, new MYR6.26 TP from MYR7.07, 1% downside with c.4% yield. Kotra Industries’ 2QFY23 (Jun) earnings came in above our and Street expectations – underpinned by the surge in demand for prescription pharmaceutical products in the local market (+23% YoY), as well as the pick-up in sales from export markets (+10% YoY). Its current valuation appears rich, at 1.9SD above its 5-year historical mean of 10.3x on the back of a normalised earnings growth outlook. Note that our TP is now based on 13.5x FY24F P/E, vs 15x previously.

• 2QFY23 results overview. Kotra delivered 2QFY23 core earnings of MYR18.3m (+35% YoY, -6% QoQ), which brought 1HFY23 core earnings to MYR37.9m, ie at 62% and 63% of ours and Street full-year estimates. The better-than-expected sales were mainly driven by a surge in demand for prescription pharmaceutical products in the local market (+23% YoY), as concerns emerged amid shortages of various prescriptive drugs in 2QFY23. Export sales recovered to pre-pandemic levels (+10% YoY) as Kotra benefits from the reopening of international borders. Local sales contracted by 16% QoQ, likely due to the normalised consumer demand. This was offset by a 26% QoQ growth in export sales. Kotra declared an interim dividend of 10 cents per share during the quarter.

• Margin. The company’s operating margin in 2QFY23 narrowed by 1.7ppt QoQ to 26.7%, likely dragged by an increase in advertisement and promotional expenditure to expand its brand awareness during the quarter, as its previous advertising plan was halted during the lockdown. Operating expenses spiked 14% YoY, and made up 72% of total revenue (vs 75% in 2QFY22). The spike in opex is likely driven by the higher active pharmaceutical ingredient price (API), as well as the strengthening of the USD against the MYR (2QFY23: 4.6 and 2QFY22: 4.2).

• Earning estimate. Post earnings, we raised our FY23-24F earnings by 9% and 5%. We expect Kotra’s numbers to potentially taper off moving into 2H23, following the normalisation of medicine-restocking activities.

• Valuation. Its current valuation appears rich, following the historical high earnings recorded in 2022. Kotra’s share price had been trending sideways since late Dec 2022, and we think this is likely due to the normalisation of consumer demand towards over-the-counter (OTC) products moving into 2H23, as the risk of COVID-19 infection subsided. As such, we downgrade our call to NEUTRAL, with our new TP reflecting 13.5x FY24F P/E (previously 15x). We incorporate a 4% ESG premium to our intrinsic value to derive our TP as Kotra’s ESG score stands above our country median. Key downside risks: Spike in raw material prices, unfavourable drug pricing mechanism imposed by the Government, and depreciation of MYR vs USD.

Source: RHB Research - 27 Feb 2023