Company Update: Fidson Healthcare Plc

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1 27 July 2017 In this report, we provide an update on Fidson Healthcare Plc following the opening of its World Health Organisation (WHO) certified manufacturing plant last year and the organic expansion into a new product category both of which are set to deliver sustainable earnings growth for the company. Based on this development, we have revised our FY estimates higher and increased our target price on the company to N6.54 (Previous: N2.15). Our new price target implies a 92.9% upside potential from current market price hence, we upgrade our recommendation on the company to a BUY. See key highlights below; New manufacturing facility increased scope for revenue growth: After a two year delay, Fidson Healthcare (Fidson) announced the completion and commencement of operations in its new World Health Organisation (WHO) compliant ultra-modern manufacturing facility located in Sango Ota, Ogun State. The plant is the biggest manufacturing facility in West Africa and one of the five shortlisted for WHO certification in Nigeria. It is equipped with six production lines for the production of Tablets, Capsules, Liquids, Cream & Ointments, Dry Powder and Intravenous infusions a new product line. The new plant doubled former production capacity thereby giving Fidson the capability to grow sales volume as the company ramps up production to meet growing demand for drugs in Nigeria and the greater West African region. According to management, the company witnessed a strong influx of demand for its products particularly intravenous fluids given local demand-supply gap. We project 174.3% growth in EPS by FY 17: Given the relatively improved economy, rising demand for consumer healthcare products as well as favourable policies in favour of local drug manufacturers (such as the 20% duty on imported finished medicines versus zero percent previously), we forecast FY 17 revenue and EPS at N12.9 billion and N0.52 respectively. This translates to a 69.5% YoY growth in revenue and 174.3% YoY growth in earnings in FY 17. Our earnings outlook is based on 1. Expected increase in sales volume from expanded capacity; 2. Improved FX liquidity following the aggressive supply of FX from the Central Bank of Nigeria (CBN); and 3. Expected operational cost savings to support earnings. Valuation we upgrade our recommendation on the company to a BUY: Based on the revision of our estimates, and using a DCF valuation approach covering a four-year period , we raise our target price on Fidson to N6.54 (previous: N2.15). Our target price implies a 92.9% upside to current market price hence we upgrade our recommendation on the stock to a BUY from our previous HOLD rating. Key risks to our valuation include 1. Higher than envisaged competition in the pharmaceutical sector particularly for intravenous fluids which will negatively impact on sales volume growth; 2. Delay in the expansion of production capacity as production lines reach full capacity; and 3. A weakening in the Naira which will impact negatively on production costs. Stock Data Bloomberg Ticker: Analysts: Feyisike Ilemore feyisike.ilemore@cardinalstone.com Oluwatosin Ojo, CFA* (Team Lead) Tosin.Ojo@cardinalstone.com BUY TP: N6.54 FIDSON:NL Market Price (N) 3.39 Shares Outs (Mn) 1,500 Market cap (N Mn) 5,085 Price Performance FIDSON NSE 12-month (%) month (%) YTD (%) Valuation 2016A 2017E 2018F P/E (x) P/BV (x) Div. Yield (%) YTD price performance (rebased) 1.5 ASI FIDSON Contact information invest@cardinalstone.com Source: NSE Page 1

2 Investment rationale High revenue potential from new Intravenous infusions (IV) line: With the commissioning of its new plant, Fidson Healthcare added a new product line for intravenous (IV) infusions to fully expand its parenteral division as well as meet growing demand for IV in Nigeria and other African countries. Intravenous infusions are fluids administered into the vein and they are commonly used by patients in hospitals given the prevalence of diseases such as Malaria, Cholera and Typhoid Fever. According to Fidson, the Nigeria market size for IV stands at 123 million bottles per year with an estimated value of N11.7 billion. Unmet demand is placed at c28.4 million bottles annually (23% of estimated market size). Asides Fidson, there are four major local manufacturers of infusions (see table 1 below) which we believe hold a total market share of ~70% in infusions. Fidson is confident that they can meet the infusions supply gap in Nigeria with its production capacity of c.21 million bottles per year. In January 2017, Fidson began production of infusions and has achieved 70% capacity utilization. The company expects to ramp up production in H2 17 as the manufacturing plant clocks in more operating hours, having secured a higher quantity of the required input materials (Dextrose, Plastic pellets and Sodium Chloride) for the production of infusions. We highlight that the demand potential for infusions in Nigeria is huge given the high incidence of diseases as well as the country s growing population birth rate at 39 per 1000 people according to the World Bank. Management stated that the company supplies infusions to major health care and government institutions. Given the very good prospects for infusions, we expect this sub-category to deliver sustainable revenue growth for the company. In Q1 17, sale of infusions added N200 million to the company s turnover and is expected to add N300 million to turnover in H2 17. Having fully understood the infusions market, management expects intravenous infusions to add N1.2 billion and N2.4 billion to 2018 and 2019 turnover respectively with target gross margin of 25% on average. Table 1: Major Intravenous Infusions manufacturers in Nigeria* Company *Data as at 2010 Location Installed Capacity in (500ml) bottles Daily Unique Pharmaceuticals Limited Sango-Ota, South West 48,000 DANA Industries Limited Minna, North Central 20,000 Juhel Pharmaceutical Awka, South East 192,000 Page 2

3 Figure 1: Estimated five year growth in the market for intravenous fluids in Nigeria (Million bottles) CAGR of 7.3% Source: CardinalStone Research, Fidson Healthcare Contract manufacturing underway: Fidson healthcare has begun providing contract manufacturing services on select product lines (Capsule and Dry powder lines) to local pharmaceutical companies given the excess capacity in its new manufacturing plant. We had mentioned in our initiation of coverage report click here that the company stood the chance to improve profitability through contract manufacturing especially on the back of its WHO prequalification. Discussions are still ongoing with multinationals for contract manufacturing opportunities which should be completed in the near term with production to follow. In FY 16, contract manufacturing added N30 million to revenue (0.4% of aggregate revenue) and management expects revenue contribution to be higher in FY 17. We highlight that gross margin potential from contract manufacturing is high - 40% on average in FY 16. Diversification into the lower end of the consumer health care market: Fidson plans to introduce consumer healthcare products targeted at the lower end of the market. This is in an attempt to capture the rising growth for cheaper healthcare products and boost sale volumes. This strategy is set to provide the company with a robust product portfolio across various price segments since the company currently plays in the premium segment of the health care market. In this regard, the company plans to introduce affordable essential medicines such as Anti-Malaria drugs, Anti- Fungal Creams, Anti-Infective and Ulcer care drugs. According to management, the quality and performance of the drugs will not be compromised however, the cost of packaging will be cheaper to achieve an affordable price point. Consumer income is Page 3

4 still constrained in Nigeria a fallout of the recession of 2016 and as a result, some middle income consumers are notably moving from premium healthcare brands to cheaper value brands. This certainly indicates that there s future growth potential in the value healthcare segment. While we foresee a potential risk of market cannibalization for its premium products, management believes that the sales of its premium brands will not suffer. In fact, by this strategy, the company expects to increase its overall customer base while leveraging on its strong brand. Management also believes that this strategy will support revenue. However, given that value products are lower margin products, we do not envisage any significant transmission to profitability margins. Government policies supportive of revenue growth: The Federal Government increased the import duty tariff on imported finished pharmaceutical products to 20% from zero percent as contained in the ECOWAS Common External Tariffs (CET). This policy was effected to encourage local pharmaceutical manufacturers. We highlight that a major obstacle to growth in pharmaceutical industry is the saturation of cheaper imported medicines in the market. We highlight that Nigeria currently imports ~70% of medicines. But with investments in recent years, which have expanded the industrial base for pharmaceuticals in the country, we believe that Nigeria is now capable of producing these products in-country to meet national demand. On the back of this, the company has reduced the percentage of its imported finished brands to 40% from 60%. In our view, we believe Fidson will enjoy increased patronage for its drugs as its products become more available and relatively cheaper when compared to imported brands. Therefore, we expect Fidson to snatch up market share from imported brands which will boost turnover. The federal government also plans to increase National Health Insurance Scheme (NHIS) penetration to 35% targeted at children and internal displaced persons. The key policy thrust of the NHIS is ensuring that Nigerians access quality medicines at affordable prices. Hence, Fidson Healthcare is well positioned to capture the upside from this policy on the back of the company s recent strategy to introduce cheaper healthcare products targeted at the lower end of the market and as the federal government plans to encourage the local drug industry through the patronization of locally manufactured drugs under the NHIS. Import duty tariff on raw materials likelihood of falling: The Minister of Health Professor Isaac Adewole during his visit to the newly completed plant, suggested plans to review the tariff on imported raw materials required for drug production. This was in a bid to support investments in the pharmaceutical industry. We note that currently, the CET places a 5% - 15% duty tariff on imported raw materials and packaging for drug production. Given that 95% of raw materials required for the industry is imported, we believe this policy, if implemented, will be welcomed by the Industry and will give big drug manufacturers like Fidson the opportunity to produce Page 4

5 at a relatively cheaper cost thereby boosting gross margin which will drive earnings growth. Expansion of its distribution network: To ensure widespread distribution of its products as well as ensure ready accessibility, Fidson Healthcare is currently investing in its distribution network. The company plans to have large depots in all regions of the country such that they can meet demand within 24 hours of request. In our view, this strategy holds potential for growth in volume given the nature of demand such that health institutions require speedy delivery of products once requested. Company outlook short and medium term Revenue growth expected on capacity expansion: Following the remarkable topline performance in H1 17 (revenue up 155.3% YoY), we expect another impressive performance in H2 17 given the expanded capacity to meet sustained growth in demand for consumer healthcare products. We also look to increased demand for the company s intravenous infusions products to support turnover growth in FY 17. Thus, we project a revenue growth of 69.5% YoY in FY 17 to N12.9 billion. Over the medium term, we project a turnover CAGR of 4.5% on the back of expected higher turnover contribution from the infusions product segment as well increased contract manufacturing opportunities. As highlighted earlier, the company is already in discussions with multinational companies on contract manufacturing of pharmaceutical which we expect will be completed in In addition, we believe Fidson can deliver on our estimated average revenue growth given its diversification into cheaper products as well as support from government regulation and policies which will increase local patronage thereby ensuring steady volume growth for the company. The scope to increase capacity utilization through the change in technology without necessarily constructing a new plant gives the company the ability to meet future increases in demand for medicines. Moderation in cost of sales ratio expected in FY 17: Fidson maintained its FY 15 cost of sales ratio of 47% in FY 16 despite FX pressures that affected the profitability margins of manufacturing companies. Therefore, with improved FX availability, we expect to see a moderation in cost of sales ratio in FY 17. The company attested to sourcing a substantial portion of its FX requirement from the interbank and plans to achieve a blended exchange rate of N380/$ in FY 17 which in our view is positive given that the company sourced most of its FX from the expensive parallel market in FY 16. Also, the increase in the proportion of locally manufactured products following the increase in the import duty for finished products (reviewed to 20% from 0%) further supports our expectation of a moderation in cost of sales ratio in FY 17. Given the above, our gross profit projection for FY 17 stands at 53.3% (FY 16: 53.0%). Our average gross margin for is forecasted at 53.5%, supported by economies of scale as the company grows sales volume as well as access to pipeline gas which is 47.4% and 73.6% cheaper than compressed natural gas (which is currently in use by Page 5

6 the company) and diesel respectively. The company stated that it s on the waiting list to access piped gas which will most likely commence in Earnings recovery driven by expected growth in turnover: Given the 10.6% reduction in short term loans (N1.2 as at H1 17 versus N1.4 as at Q1 17), we expect relatively lower interest expense in H2 17. Despite this, we forecast a 35.3% YoY increase in interest expenses in FY 17 given the low base of FY 16. Supported by our expectation of a moderation in operating expenses to sales ratio, our after-tax earnings is estimated at N869 million which implies a 174.3% YoY growth from FY 16. We note that the significant growth is primarily due to the low earnings base of FY 16. In , we project an after-tax earnings CAGR of 14.6%. This expectation is on the back of gross margin expansion as well as a downtrend in interest charges. Also, we expect Fidson to continue in its efforts to cap operating expenses which is positive for earnings growth. In our initiation of coverage report on Fidson - click here - we stated that the new manufacturing plant qualifies for pioneer tax status, which essentially would exclude the company from corporate income tax for up to 5 years. The Minister of Health also hinted at a likely tax relief during his visit to the plant. The company hasn t begun to enjoy this benefit as H1 17 effective tax rate was at 32%. We believe the tax exemption will come through in the near term which will provide a further boost to earnings and dividend pay-out. Valuation and recommendation We upgrade our recommendation to a BUY: Based on our revised estimates above, and using a Discounted Cash Flow valuation approach which covers a four-year period , we raise our target price on Fidson to N6.54 (previous: N2.15). Our target price implies a 92.9% upside to current market price hence we upgrade our recommendation on the stock to a BUY from our previous HOLD rating. Fidson is trading on a forward 2017 P/E of 5.3x compared to Bloomberg Middle-East and Africa peers of 15.5x Key risks to our valuation: Key risks that could limit the upside include 1. Higher than envisaged competition in the pharmaceutical sector particularly for intravenous fluids which will negatively impact on sales volume growth; 2. Delay in the expansion of production capacity as production lines reach full capacity; and 3. A weakening in the Naira which will impact negatively on production costs. Page 6

7 H1 17 Performance Review Triple digit growth in H1 17 turnover: In H1 17, Fidson Healthcare Plc reported a 155.3% YoY increase in revenue to N6.7 billion, primarily driven by base effects as well as sales volume increase following the expanded capacity from its new manufacturing plant. The major revenue segments showed impressive YoY turnover growth as the Ethical and Over-the-Counter (OTC) divisions grew by 121.2% YoY and 189.5% YoY and contributed 63.2% and 36.4% to H1 17 aggregate revenue respectively. The growth in these segments offset the 47.7% YoY decline in the consumer segment. On a quarterly basis, Q2 17 revenue declined by 5.2% QoQ. Fidson Quarterly revenue performance trend (N Million) ,805 3,128 3,422 3, ,229 2,127 2,050 1,217 1,393 1, Q1'15 Q2'15 Q3'15 Q4'15 Q1'16 Q2'16 Q3'16 Q4'16 Q1'17 Q2'17 Source: Company s filings Substantial growth in earnings driven by strong topline figure: Despite the improvement in FX supply in the interbank market as well as increased sales volume which should reduce the unit cost of its products, the company reported a 61bps YoY contraction in gross margin to 51.3% in H1 17. On a quarterly basis, gross margin also contracted by 54bps QoQ to 51.0% (Q1 17: 51.6%). In spite of this, after-tax earnings however rose by % YoY to N466.1 million in H1 17. While base effects contributed to the substantial growth in earnings, we highlight the expansion in operating profit margin rose which increased to 16.4% from 13.7% in H1 16. This was primarily the result of a 365bps moderation in operating expenses to sales ratio in H1 17. On a quarterly basis, earnings also grew by 89.5% QoQ to N305 million, driven by a 686bps moderation in operating expenses as well as a 9.8% decline in finance costs to N193 million. Page 7

8 Financial Statements and Key Ratios Fidson Healthcare Plc Income Statement 2015A 2016A 2017E 2018F 2015A 2016A 2017E 2018F Revenue 8,211 7,655 12,975 14, Cost of Sales (3,859) (3,600) (6,056) (6,537) (19) (18) (29) (21) Gross Profit 4,352 4,055 6,919 7, Distribution And Admin Expenses (2,930) (3,070) (4,931) (5,414) (15) (15) (23) (18) EBITDA 1, ,988 2, Other Income EBIT/Operating profit 1,516 1,090 2,114 2, Interest Expense/Income (678) (647) (837) (676) (3) (3) (4) (2) Pre-tax earnings ,278 1, Taxation (94) (127) (409) (486) (0) (1) (2) (2) Profit after tax , Statement of Financial Position 2015A 2016A 2017E 2018F 2015A 2016A 2017E 2018F Assets Property, Plant and Equipment 11,501 12,206 12,534 13, Investment Property Intangible Assets Held to maturity Available for sale Inventories 698 1,086 1,437 1, Trade and other receivables 3,780 2,420 2,844 3, Prepayments Cash and Bank Equivalents Total Assets 16,670 16,667 17,730 19, Liabilities Trade and other payables 4,212 4,229 4,714 6, Short Term Financial Liabilities 1,883 1,956 1, Creditors /Govt Revenue Taxation Dividend (unclaimed) Long term loans 2,762 2,431 2,581 2, Deferred taxation Deferred revenue Retirement benefits obligation Government Grant Total Liabilities 10,347 10,074 10,343 11, Capital and Reserves Share Capital Share Premium 2,973 2,973 2,973 2, Revenue Reserve 2,602 2,872 3,666 4, Non-Controlling Interest (2) (2) (2) (2) (0) (0) (0) (0) Shareholders' funds 6,324 6,593 7,387 8, Total liabilities and equity 16,670 16,667 17,730 19, Key Ratios 2015A 2016A 2017E 2018F 2015A 2016A 2017E 2018F Profitability Return on Average Assets 4.5% 1.9% 4.9% 5.7% 30.1% 22.2% 23.5% 123.5% Return on Average Equity 12.3% 4.9% 12.4% 14.1% 8.2% 5.6% 6.6% 106.6% EBITDA Margin 17.3% 12.9% 15.3% 15.1% 17.3% 12.9% 15.3% 15.1% EBIT Margin 18.5% 14.2% 16.3% 16.2% 18.5% 14.2% 16.3% 16.2% Pre-tax Profit Margin 10.2% 5.8% 9.8% 11.4% 10.2% 5.8% 9.8% 11.4% Net Profit Margin 9.1% 4.1% 6.7% 7.9% 9.1% 4.1% 6.7% 7.9% Valuation Multiples P/E (x) P/B (x) Dividend Yield (%) 1.7% 1.7% 2.1% 2.7% 1.7% 1.7% 2.1% 2.7% Page 8

9 Disclosure Analyst Certification The research analyst(s) denoted by an * on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analysts denoted by an * on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst(s) cover in this research) that: (1) all of the views expressed in this report accurately articulate the research analyst(s) independent views/opinions, based on public information regarding the companies, securities, industries or markets discussed in this report. (2) The research analyst(s) compensation or remuneration is in no way connected (either directly or indirectly) to the specific recommendations, estimates or opinions expressed in this report. Analysts Compensation: The research analyst(s) responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Investment Banking and Asset Management. Investment Ratings CardinalStone employs a 3-step rating system for equities under coverage: Buy, Hold, and Sell. Buy % expected share price performance Hold +0.00% to % expected share price performance Sell < 0.00% expected share price performance A BUY rating is given to equities with strong fundamentals, which have the potential to rise by at least % between the current price and the analyst s target price An HOLD rating is given to equities with good fundamentals, which have upside potential within a range of +0.00% and %, A SELL rating is given to equities that are highly overvalued or with weak fundamentals, where potential returns of less than 0.00% is expected, between the current price and analyst s target price. A NEGATIVE WATCH is given to equities whose fundamentals may deteriorate significantly over the next six (6) months, in our view. CardinalStone Research distribution of ratings/investment banking relationships as of June 30, 2017 Rating Buy Sell Hold % of total recommendations 57% 17% 23% % with investment banking relationships 6% 0% 0% Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any security recommended herein. You can contact the analyst named on the front of this note for further details. Frequency of Next Update: An update of our view on the company (ies) would be provided when next there are substantial developments/financial news on the company. Conflict of Interest: It is the policy of CardinalStone Partners Limited and its subsidiaries and affiliates (individually and collectively referred to as CardinalStone ) that research analysts may not be involved in activities that suggest that they are representing the interests of Cardinal Stone in a way likely to appear to be inconsistent with providing independent investment research. In addition, research analysts reporting lines are structured to avoid any conflict of interests. However, sales and trading departments may trade as principal, based on the research analyst s published research. Therefore, the proprietary interests of those Sales and Trading departments may conflict with your interests. Page 9

10 Company Disclosure: CardinalStone may have financial or beneficial interest in securities or related investments discussed in this report, which could, unintentionally, affect the objectivity of this report. Material interests, which CardinalStone has with companies or in securities discussed in this report, are disclosed hereunder: Company Fidson Healthcare Plc Disclosure G, H, J a. The analyst holds personal positions (directly or indirectly) in a class of the common equity securities of the company b. The analyst responsible for this report as indicated on the front page is a board member, officer or director of the Company c. CardinalStone is a market maker in the publicly traded equities of the Company d. CardinalStone has been lead arranger or co-lead arranger over the past 12 months of any publicly disclosed offer of securities of the Company e. CardinalStone beneficially own 1% or more of the equity securities of the Company f. CardinalStone holds a major interest in the debt of the Company g. CardinalStone has received compensation for investment banking activities from the Company within the last 12 months h. CardinalStone intends to seek, or anticipates to receive compensation for investment banking services from the Company in the next 3 months i. The content of this research report has been communicated with the Company, following which this research report has been materially amended before its distribution j. The Company is a client of CardinalStone k. The Company owns more than 5% of the issued share capital of CardinalStone l. CardinalStone has other financial or other material interest in the Company Important Regional Disclosures The analyst(s) involved in the preparation of this report may not have visited the material operations of the subject Company (ies) within the past 12 months. To the extent this is a report authored in whole or in part by a Non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any Non-U.S. analyst contributors: The Non-U.S. research analysts (denoted by an * in the report) are not registered/qualified as research analysts with FINRA; and therefore, may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Each analyst (denoted by an *) is a Non-U.S. Analyst and is currently employed by Cardinal Stone. Legal Entities Legal entity disclosures: CardinalStone Partners is authorized and regulated by the Securities and Exchange Commission (SEC) to conduct investment business in Nigeria. Page 10