• Downgrade to NEUTRAL from Buy with a new MYR5 TP from MYR5.40, 5% upside. 9HFY24 (Jun) earnings came in below our and Street’s expectations – attributed to the slowdown in consumer demand for supplement products in the local market. While Malaysia’s economic growth is set to accelerate in 2Q24 and 3Q24 (as suggested by our economics team), we think Kotra Industries’ near-term earnings recovery should remain choppy, given the potentially higher effective tax (in the absence of tax losses to be recognised moving forward) and slowing consumption trend.

• Results overview. Kotra’s 9HFY24 fell short of expectations after registering core earnings of MYR34m (-38% YoY) at 55% and 61% of our and Street’s full-year estimates. The YoY decline in core earnings were on a decrease in sales of pharmaceutical products in the local and export markets, and decline in consumer demand towards supplement products domestically. On a QoQ basis, export market sales contracted 14% QoQ – offset by a 3% QoQ improvement locally. Core profit slipped 34% QoQ due to higher tax provisions in view of the reversal of deferred tax assets arising from the utilisation of tax losses and incentives brought forward.

• Margins. 3QFY24 operating margin grew 4.2ppts QoQ to 24.9% – likely driven by a better product mix (higher contributions from local sales). YoY wise, operating margins were lowered by 5ppts as opex rose 5% YoY. Generally, export sales tend to command lower margins vs local sales, given that the former requires extensive advertisement & promotional spending and distribution costs.

• Outlook. Following a better-than-expected trade performance (Malaysia’s 1Q24 GDP growth was at 4.2% YoY), our economics team expects the nation’s economic growth to accelerate above 5% YoY in 2Q24 and likely persist into 3Q24 – driven by a stepping up in trade and manufacturing activities. While we remain positive on the outlook of Malaysia’s economic prospects, we expect near-term subdued consumer demand towards consumer healthcare products, as consumer health awareness dissipates post the COVID 19 pandemic.

• Earnings estimates and valuation. We trim our FY24F-25F earnings by 9% each, taking into account the higher effective tax rate moving forward. Post adjustments, our TP is now lowered to MYR5 based on an unchanged 12x FY25F P/E, which represents 0.8SD above Kotra’s pre-COVID-19 5-year historical mean of 11x. The company currently trades at 12x FY25F P/E. Our TP incorporate an ESG premium of 2%, as its 3.1 ESG score is above our 3.0 country median. Key downside/upside risks: Spike/decline in raw material prices, lower-/higher-than-expected consumer demand for supplement products, and depreciation/appreciation of the MYR vs the USD.

Source: RHB Research - 23 May 2024