Not Rated. Hovid (HOV MK) Boost From Drug Patent Expiry. Consumer Non-cyclical - Healthcare Target Price: MYR0.42 Market Cap: USD82.6m Price: MYR0.

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1 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Vol m Trading Idea, Hovid (HOV MK) Not Rated Consumer Non-cyclical - Healthcare Target Price: MYR0.42 Market Cap: USD82.6m Price: MYR0.36 Boost From Drug Patent Expiry Macro Risks Growth Value Price Close Relative to FTSE Bursa Malaysia KLCI Index (RHS) Hovid sees great potential in the coming years. It recently launched generic versions of drugs which went off patent An estimated USD15bn in medicines have gone off patent in 2013, boosting its potential new products pipeline. Plans are already in place to raise production capacity by 30% in We value the stock at 42 sen, pegged to 17x CY14F fully diluted EPS an 18% upside Source: Bloomberg Avg Turnover (MYR/USD) m/0.62m Cons. Upside (%) 19.4 Upside (%) wk Price low/high (MYR) Free float (%) 57 Shareholders (%) Ho Sue San 37.6 Lembaga Tabung Haji 5.2 Shariah compliant We hosted a corporate luncheon with Hovid for our clients in Dec Management was represented by CFO and executive director Mr Andrew Goh. Given the current trend of patent protection expiry for major innovator drugs, management was upbeat on Hovid s prospects as a generic drug manufacturer. We concur with this view. The company is now ramping up capacity to capitalise on this trend. Tasty takeaways from the luncheon. Among the notable takeaways from the luncheon were the fact that Hovid: i) recently launched generic versions of two drugs whose patent protection recently expired these medicines generated a combined USD9.7bn annually in global sales before their patents ended, and ii) is working on a further six generic versions of major drugs in Based on estimates, there at least 17 drugs worth USD15bn in total global sales whose patents expired last year. 3-year (FY13-16) net profit CAGR of 21.9%. Hovid plans to launch new products annually going forward. To support its ambitions, the company is: i) expanding capacity at its tablet and capsule plant this year with a planned initial 30% increase, ii) setting up its own bioequivalence test centre for new generic drugs, and iii) building a new central warehouse to better manage the increase in inventory. MYR0.42 FV, 18% upside. We value Hovid at 17x CY14F fully diluted EPS, a discount to global peers average of 18x 2014 earnings. That said, while there is a substantial warrant base, we do not think conversions are likely at this juncture. Pre-dilution, Hovid s share price would be 61 sen at 17x P/E. We like the company for its: i) 21.9% 3-year earnings CAGR, ii) strong exposure to the export market ie wellpositioned to benefit from further USD/MYR appreciation, iii) net cash position, and iv) decent 15% ROE. This stock is Not Rated. Chong Ooi Ming chong.ooi.ming@rhbgroup.com Forecasts and Valuations Jun-11 Jun-12 Jun-13 Jun-14F Jun-15F Total turnover (MYRm) Reported net profit (MYRm) (6.1) Recurring net profit (MYRm) Recurring net profit growth (%) na Recurring EPS (MYR) Recurring P/E (x) P/B (x) P/CF (x) EV/EBITDA (x) Return on average equity (%) (5.9) Net debt to equity (%) net cash net cash net cash Our vs consensus EPS (%) See important disclosures at the end of this report Powered by EFA TM Platform 1

2 Industry Outlook Tasty Luncheon Treats Increasing trend of major drug patents expiring. We understand that generic drug manufacturers worldwide are preparing to launch their own versions of top-selling innovator drugs whose patents have expired/are expiring in This trend is driving pharmaceutical share prices. This is evident in mature generic drug manufacturing hubs like India. In the past 12 months, selected drug manufacturers have outperformed the benchmark S&P BSE SENSEX index on anticipation of new product launches. Figure 1: Superb outperformance by Indian generic pharmaceutical companies Ranbaxy Laboratories Cipla (%) Dr. Reddy's Laboratories Lupin Ltd Sun Pharmaceuticals Sensex Index Jan, 13 Apr, 13 Jul, 13 Oct, 13 Jan, 14 Source: Bloomberg Luncheon takeaway No. 1 two products already launched. Among major patents that expired in 2012, it was revealed over lunch that Hovid launched Plavix (an anti-clot or blood thinner that prevents heart attacks or strokes) and Singulair (an oral asthma and allergy treatment). Before their patents ended in May and Aug 2012 respectively, both drugs together achieved worldwide sales of USD9.7bn per annum. Assuming Hovid is able to capture just 0.1% of existing sales taking into account: i) competition from other manufacturers, and ii) lower selling prices this will translate into MYR31.0m in new sales per annum based on an exchange rate of MYR3.20 to USD1, or a 17% uplift to FY13 revenue from these two products alone. Figure 2: Hovid's two new products original sales Product Company Source: FiercePharma, RHB estimates Worldwide sales (USDm) Plavix Bristol Myers Squibb 6,154 6,315 3,014 Singulair Merck & Co 3,224 3,356 2,178 Luncheon takeaway No. 2 six new drugs coming soon. During the luncheon, management also shared that Hovid has a further six products either under development or pending registration for While remaining tight-lipped on the specific products, we understand that the company s next few products will focus on high demand drugs required for longer-term treatments like diabetes, heart ailments and cholesterol, amongst others. USD15bn market opening up in 2014? We gather that, of the estimated 17 innovator drugs whose patents expired in 2013, the top seven best-selling drugs from this figure generated c.usd14bn in sales in We note too that all seven were used in the treatment of long-term ailments. The remaining 10, on the other hand, generated close to USD1bn in total. Assuming that Hovid is able to launch just two of the lowest selling drugs, ie Tricor and Niaspan, and capture just 0.1% of the 2012 global sales figure, this will translate into MYR6.2m in new sales, or equal to 3.6% of FY13 revenue. If the company is eyeing the two highest selling drugs, ie Humalog and Cymbalta, this could generate MYR23.8m in sales (based on the assumptions above), or up to 13.5% of FY13 topline. See important disclosures at the end of this report 2

3 Figure 3: Key innovator drug sales and patent expiry dates in 2013 Month Product Company Disease 2012 Sales (USDm) Jan Tricor (fenofibrate) Abbott Laboratories Cholesterol 1,111.0 May Humalog (insulin lispro) Eli Lilly Diabetes 2,520.0 Aug Procit (epoetin alfa) Johnson & Johnson Anemia 1,410.0 Sept Niaspan (niacin ER) Abbott Laboratories Cholesterol Nov Aciphex (rabeprazole) Eisai Acid reflux/heartburn 1,930.0 Dec Cymbalta (duloxetine) Eli Lilly Depression 4,900.0 Dec Neupogen (filgrastim) Amgen Cancer 1, ,996.0 Source: FiercePharma Background & Business Profile Healing is Hovid s heritage. Hovid began in 1941 and was founded by Dr Ho Kai Cheong with its initial Ho Yan Hor herbal tea product, which still accounts for up to 5% of total sales. In the 1980s, Mr David Ho, the current MD, led Hovid into the pharmaceutical manufacturing business. Malaysian pharmaceutical export leader. Hovid now possesses more than 350 different types of generic drugs, over the counter (OTC) medicines and dietary supplements in its product portfolio. It also exports its products to over 45 countries, with exports making up 52.5% of FY13 s total sales. Of these exports, the majority are Asia-centric (33.4%), while Africa (17.9%) is the new growth market. We see this strong export success stemming from: i) Malaysia being a member of the Pharmaceutical Inspection Convention and Pharmaceutical Inspection Co-operation Scheme (PIC/S), and ii) Hovid being the sole Malaysian supplier to the United Nations Children's Fund (UNICEF) and United Nations Relief and Works Agency (UNRWA). Locally, Hovid s distribution channels cover private general practitioner (GP) clinics, pharmacies, hospitals and the Ministry of Health (MOH). Domestic sales account for 47.5% of 2013 s total sales, of which only c.10% are to the MOH at present. Generic Drugs What are generic drugs? According to the US Food and Drug Administration (FDA), a generic drug is identical or, in industry parlance, bioequivalent to a brand name drug in terms of: i) dosage form, ii) safety, iii) strength, iv) route of administration, v) quality, vi) performance characteristics, and vii) intended use. Although generic drugs are chemically identical to their branded counterparts, they are typically sold at substantial discounts. The FDA quotes the US Congressional Budget Office as stating that generic drugs save US consumers an estimated USD8-10bn a year at retail pharmacies. Are generic drugs as effective as brand-name drugs? Yes. A generic drug is the same as a brand-name drug in terms of dosage, safety, strength, quality, the way it works, the way it is taken and the way it should be used. The FDA requires generic drugs to have the same high quality, strength, purity and stability as their brand-name counterparts. See important disclosures at the end of this report 3

4 How are generic drugs cheaper? Creating a new drug costs a lot of money, as they must undergo: i) pre-clinical animal testing, ii) invitro testing, and iii) clinical (human) trials to establish safety and effectiveness. Thus new drugs, like other new products, are developed under patent protection. The patent protects the investment in the drug's development by giving the innovator company the sole right to sell the drug while the patent is in effect. When the patent expires, other drug companies can start selling a generic version of this medicine. Since generic drug makers do not develop a drug from scratch, the cost to bring the drug to market is less. Therefore, generic drugs are usually less expensive than brand-name ones. However, generic drug makers must show the FDA that their product performs in the same way as the brand-name drug. How are generic drugs approved? Drug companies must submit an abbreviated new drug application (ANDA) for approval to market a generic product. The ANDA process does not require the drug sponsor to repeat costly animal and clinical research on ingredients or dosage forms already approved for safety and effectiveness. Instead generic applicants must demonstrate via tests that show that their products are bioequivalent. Financials & Forecast Consistently strong earnings trend. For FY09-13, Hovid enjoyed a 4-year pharmaceutical sales CAGR of 11.3%. Excluding losses from former subsidiary Carotech, the estimated net profit CAGR for this period would have been 15.2%. The company s EBITDA margins too are resilient, sustaining at between 19-22% in the last five years. The recent margins erosion is attributed to the implementation of minimum wage and margins are expected to normalise going forward. Figure 4: Sales, EBITDA growth and margins since FY09 (MYR m) Revenue LHS EBITDA LHS EBITDA Margin (%) RHS 22% 21% 20% 19% 18% 17% 16% 15% 14% 13% 12% Source: Company data Ramping up capacity and new R&D centre. Hovid is about to start construction on an expansion of its tablet and capsule facility in Chemor, Perak, which will initially boost production capacity by 30% (in Phase 1). This facility will carry approvals from US, EU and Australian pharmaceutical authorities. The company is also setting up a new research & development (R&D) centre in Penang that will allow it to conduct its bioequivalence tests on new generic drugs in-house. Hovid is also building a new central warehouse, which will allow the company to benefit from cost and efficiency savings after consolidating its seven existing warehouses. Going forward, the company aims to launch new products annually. See important disclosures at the end of this report 4

5 3-year (FY13-16) 21.9% PAT CAGR forecast. We forecast MYR192.2m/ 214.2m/239.0m in revenue and MYR24.9m/29.8m/35.5m in net profit for FY14/15/16, on the back of: i) EBITDA margins of % improving with better economies of scale and cost controls (FY10-13: EBITDA margins ranged between %), ii) production growth of we are assuming a gradual ramping up of its new plant capacity expansion, iii) ASP increases of c.3%, iv) export sales gradually expanding to 56.6% of total sales by FY16 (FY13: 52.5%), and v) a stable exchange rate of MYR3.20 to USD1. Figure 5: Key earnings assumptions May-14 May-15 May-16 Revenue Ave price increases 3.0% 3.0% 3.0% Quantity increases 8.1% 8.2% 8.3% USD - MYR forecast Exports (%) of revenue 53.9% 55.2% 56.6% EBITDA Margin (%) 20.7% 22.2% 23.6% Net Profit (MYR m) Source: RHB estimates Valuations MYR0.42 FV, 18% upside. We value Hovid at 17x fully diluted CY14F EPS, a discount to global peers average of 18x 2014F earnings. Our FV of 42 sen takes into account its 381m warrants and offers an 18% upside to 9 Jan s closing price of MYR This stock is Not Rated. We ascribe the discount due to Hovid being the smallest stock. That said, we feel a premium to local peer Pharmaniaga (PHRM MK, Not Rated) is warranted on the former s higher export sales and implied growth potential. Pharmaniaga, on the other hand, is orientated towards the domestic market. Also, Hovid achieves a decent 15.0% ROE vs Pharmaniaga s 16.4% despite being in net cash. By comparison, Pharmaniaga s gearing stands at 50.3%. Though much smaller than its larger Indian peers, Hovid s facilities in Ipoh, Perak, are completely certified while Indian pharmaceutical operators multiple facilities have varying degrees of certification. In May 2013, Ranbaxy (RBXY IN, NR) was fined USD500m by the US FDA and the company has closed over half a dozen plants over alleged irregularities. Figure 6: Generic drug manufacturers peer comparison Call Country Market Cap (USDm) P/E (x) P/E (x) EV/EBITDA (x) EV/EBITDA (x) ROE (%) P/BV (x) Net gearing Hovid not rated Malaysia (6.3) Pharmaniaga not rated Malaysia Ranbaxy Laboratories not rated India 3, Cipla not rated India 5, (8.6) Dr. Reddy's Laboratories not rated India 6, (2.2) Lupin Ltd not rated India 6, (4.2) Sun Pharmaceuticals not rated India 20, (34.6) Aspen Pharmacare not rated South Africa 11, Adcock Ingram Holdings not rated South Africa 1, Average Source: RHB estimates, Bloomberg See important disclosures at the end of this report 5

6 Warrant dilution concerns. A potential concern will be the dilution from its outstanding 381m warrants at an exercise price of 18 sen, which will balloon Hovid s share base by 50% if fully converted. This will reduce Hovid s 2014 EPS to 2.7 sen (from 3.9sen) after taking into account the higher interest income. Hence, our 42 sen FV on the company. That said, we feel that there is little incentive at present to exercise these warrants, as: i) they will only expire in June 2018, ii) they currently offer warrant holders 2x gearing to the mother share, and iii) currently Hovid does not pay dividends. And, as Hovid will conserve cash in the next few years for expansion, we expect nominal dividends at best over the coming years. At 17x P/E pre-dilution, Hovid s FV would be 62 sen. Figure 7: EPS dilution Impact Source: RHB estimates May 2014 May 2015 May 2016 Net Profit (MYR m) Current share base Fully diluted share base 1, , , EPS Fully diluted EPS Investment Risks Competition from India. Hovid lacks the economies of scale and lower labour cost enjoyed by the big Indian drug manufacturers. Should these companies launch a generic version first, the company may find it challenging to market its own products. Trade barriers in emerging markets. Hovid exports a significant percentage of its products to developing countries, eg Nigeria, the Philippines and Cambodia. These are its main growth markets too. Should these countries impose quotas or other limitations on drug imports, Hovid will be significantly affected. Margin slippage. Our margin projections could come under risk if a drastic switch in supplier pricing or product mix occurs. Growth prospects dependant on patent expiry. In 2012, Pfizer (PFE US, NR) extended patent protection for its Viagra product to Should other major drugs have their patent protections extended, this will deprive Hovid of a host of new potential products. See important disclosures at the end of this report 6

7 Financial Exhibits Profit & Loss (MYRm) Jun-11 Jun-12 Jun-13 Jun-14F Jun-15F Total turnover Gross profit Gen & admin expenses (134) (134) (145) (158) (174) Operating profit Operating EBITDA Depreciation of fixed assets (5) (6) (6) (6) (7) Operating EBIT Net income from investments - (9) Interest income Interest expense (7) (3) (2) (1) (1) Exceptional income - net (17) Pre-tax profit (2) Taxation (4) (6) (5) (8) (11) Minority interests 0 (0) (0) (0) (0) Profit after tax & minorities (6) Reported net profit (6) Recurring net profit No major capex required post 2015 Cash flow (MYRm) Jun-11 Jun-12 Jun-13 Jun-14F Jun-15F Operating profit Depreciation & amortisation Change in working capital 28 (4) 4 (5) (6) Operating cash flow Interest received Interest paid (7) (3) (2) (1) (1) Tax paid (4) (5) (3) (8) (11) Cash flow from operations Other investing cash flow Cash flow from investing activities Proceeds from issue of shares (0) (9) Increase in debt (300) (6) (31) - - Other financing cash flow (0) Cash flow from financing activities (300) (16) (3) - - Cash at beginning of period Total cash generated (255) Implied cash at end of period (246) See important disclosures at the end of this report 7

8 Financial Exhibits Balance Sheet (MYRm) Jun-11 Jun-12 Jun-13 Jun-14F Jun-15F Total cash and equivalents Inventories Accounts receivable Other current assets Total current assets Total investments Tangible fixed assets Intangible assets Total other assets Total non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Total long-term debt Other liabilities Total non-current liabilities Total liabilities Share capital Retained earnings reserve Other reserves Shareholders' equity Minority interests Other equity Total equity Total liabilities & equity Key Ratios (MYR) Jun-11 Jun-12 Jun-13 Jun-14F Jun-15F Revenue growth (%) (58.0) Operating profit growth (%) (9.6) Net profit growth (%) (89.7) EPS growth (%) (89.7) (2.1) 5.0 Bv per share growth (%) (5.7) Operating margin (%) Net profit margin (%) (3.9) Return on average assets (%) (1.6) Return on average equity (%) (5.9) Net debt to equity (%) (9.1) (31.6) (29.5) Recurrent cash flow per share See important disclosures at the end of this report 8

9 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 SWOT Analysis Certification of all its manufacturing facilities Strong back log of new products pending registration Multibillion dollar innovator drugs coming off patent Key export markets are developing countries with increasing health care expenditures Big pharmaceutical companies may attempt to prolong patent life Larger GLC drug manufacturers might stymie its ability to grow locally At present lacks the ability to develop its own drugs Limited inroads with Malaysian Government clinics and hospitals P/E (x) vs EPS growth P/BV (x) vs ROAE ,400% 1,240% 1,080% 920% 760% 600% 440% 280% 120% -40% -200% % 10% 0% -10% -20% -30% -40% P/E (x) (lhs) EPS growth (rhs) P/B (x) (lhs) Return on average equity (rhs) Company Profile Hovid is a Malaysian generic drugs manufacturer, which derives more than half of its sales from exports. The company s manufacturing facilities are located in Perak and it is in the midst of setting up a research & development centre in Penang. See important disclosures at the end of this report 9

10 Recommendation Chart 0.40 Price Close Jan-09 Apr-10 Jul-11 Nov-12 Source: RHB estimates, Bloomberg Date Recommendation Target Price Price Source: RHB estimates, Bloomberg See important disclosures at the end of this report 10

11 RHB Guide to Investment Ratings Buy: Share price may exceed 10% over the next 12 months Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain Neutral: Share price may fall within the range of +/- 10% over the next 12 months Take Profit: Target price has been attained. Look to accumulate at lower levels Sell: Share price may fall by more than 10% over the next 12 months Not Rated: Stock is not within regular research coverage Disclosure & Disclaimer All research is based on material compiled from data considered to be reliable at the time of writing, but RHB does not make any representation or warranty, express or implied, as to its accuracy, completeness or correctness. No part of this report is to be construed as an offer or solicitation of an offer to transact any securities or financial instruments whether referred to herein or otherwise. This report is general in nature and has been prepared for information purposes only. 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