• D/G to SELL from Neutral, new MYR4.90 TP from MYR6.26, 13% downside and c.4% yield. 3QFY23 (Jun) earnings came in above our and Street’s expectations thanks to the pick-up in export sales and demand surge for prescription pharmaceutical products locally. The current valuation of 12x FY24F P/E – 0.6SD above Kotra Industries’ pre-COVID-19 5-year historical average mean of 11x – is on a normalised earnings growth outlook. Our TP incorporate an ESG premium of 6%, as Kotra’s ESG score is above our country median.

• Results overview. 3QFY23 core profit came in at of MYR17m (+5% YoY, -5% QoQ), bringing 9MFY23 core earnings to MYR55m, accounting for 82% and 82% of our and Street’s full-year estimates. The robust performance was driven by increases in export sales (+43% YoY) and surge in local demand for prescription pharmaceutical products. This was offset by a drop in supplement products sales domestically, bringing Kotra’s local sales segment down 3% YoY.

• Margins. 3QFY23 operating margin held up 3.2ppts QoQ to 29.9%, likely help by the easing of key raw material costs. This was offset by advertising & promotions spending in the export segment, as Kotra’s previous advertising plan was halted during the pandemic lockdowns.

• Earnings estimate. We leave our earnings estimates unchanged, as we expect Kotra’s results to potentially taper off as it moves into 2HCY23 following the normalisation of medicine restocking activities.

• Valuation. With consumer demand on the over-the-counter (OTC) products likely to normalise moving into 2HCY23, as risk of COVID-19 infections subside, we derive our FY24F target P/E of 10x from 0.5SD below Kotra’s pre-COVID-19 5-year historical mean of 11x. Our downgrade is premised on the current rich valuation of 12x FY24F earnings – 0.6SD above its pre- COVID-19 mean – and slowdown in growth as a result of sequential weaknesses in revenue growth from OTC sales moving forward. This is as concerns over drug shortages have been resolved post the easing of supply chain congestions. Our ESG score is now 3.3 from 3.2 previously after incorporating our latest ESG framework. As such, Kotra’s ESG premium is raised to 6% from 4% as its ESG score stands above the country median.

• Key risks: Raw material price spikes, unfavourable government-imposed drug-pricing mechanisms, and MYR depreciation vs the USD.

• ESG framework update. As there is now greater focus on the E pillar on critical climate change issues, we tweaked our ESG weightage. Henceforth, we assign a 50% weightage to the E pillar, followed by 25% each to the S and G pillars. See our 2 May thematic research for more details.

Source: RHB Research - 29 May 2023