CFA Institute Research Challenge hosted in Vietnam

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1 CFA Institute Research Challenge hosted in Vietnam Vietnam CFA Institute Research Challenge Page 1

2 Student Research Report This report is published for educational purposes only by students competing in the Vietnam CFA Institute Research Challenge HAU GIANG PHARMACEUTICAL JSC Date: 13 Nov 2012 Ticker: DHG Healthcare Sector - Pharmaceutical Manufacturing Industry Ho Chi Minh City Stock Exchange, Vietnam Recommendation BUY Highlights Target price (31 Dec 2013) 78 Current Price (13 Nov 2012) 65.5 Upside 19.1% (Figures in VND 000) We initiate BUY for Hau Giang Pharmaceutical JSC (DHG or Company) with VND78,034 target price by year-end 2013, offering a 19.1% upside from its current price. DHG is Vietnam s largest pharmaceutical manufacturer measured by sales and capacity. We ground our rating on DHG s expected continued strong fundamentals, favorable market conditions and a sound expansion plan. Revenues are projected to grow at 17% CAGR during , supported by strong consumption market and the expansion investment that adds 1.6x capacity to the existing factory currently running at maximum. DHG is projected to deliver a 2012 EPS of VND6,730, up 5% from 2011 and continue to produce significant cash from operation to sufficiently fund investing and financing needs. Liquidity is expected to remain satisfactory with current ratio averaging at 2.9x for DHG serves markets with future growth approximately at 15% CAGR. DHG is expected to be well positioned to outperform the general market, driven by its leading position, nationwide distribution network, experienced management, and strong production capacity. We derive the VND78,034 weight-averaged target price using FCFE and P/E Multiple methods. We assign FCFE and Multiple valuation 70% and 30% weight respectively. Key risks to the target price include delays in operating the new factory, local currency devaluation, input price inflation and fiercer-than-expected competition. Strong operating cash, relatively sizeable market position and a competent management are expected effective risk mitigations. Table 1. Key financial data F2012 F2013 F2014 F2015 F2016 F2017 figures in VND'000,000 Net sales 2,034,525 2,490,880 2,883,929 3,344,919 3,954,688 4,684,008 5,455,235 6,225,838 Net Income 2,034,525 2,490, , , , , , ,810 OCF 286, , , , , , , ,371 EPS adjusted (VND) 5,872 6,401 6,720 7,312 7,792 8,922 10,572 11,920 DPS adjusted (VND) 1,030 4,027 1, ,338 3,569 5,286 5,960 ROE 32.9% 31.0% 27.9% 24.4% 21.6% 21.5% 22.6% 22.8% ROA 22.8% 21.8% 19.7% 17.7% 15.8% 15.8% 16.6% 16.7% Figure 1. Relative performance (by Bloomberg) Vietnam CFA Institute Research Challenge Page 2

3 INVESTMENT SUMMARY Figure 2. Historical price chart (by Bloomberg) We rate BUY for DHG with the target price of VND78,034 by year-end 2013, presenting a 19.14% upside from its current price. DHG, headquartered in Can Tho City, Mekong Delta, Vietnam, is Vietnam s largest pharmaceutical manufacturer measured by sales and capacity. Vitamins, ENT (Ear, Nose and Throat), Antibiotic, and Analgesic medicines are major product groups, generating over 85% of sales with herbal medicines and other medications generating the balance. DHG s expected continued strong fundamentals, favorable market conditions and a sound expansion plan support our rating. Revenues are projected to grow at 17% CAGR during , driven by strong consumption market and the expansion investment that adds 1.6x capacity to the existing factory currently running at maximum capacity. Antibiotic medicines are expected to continue their role as key revenue driver, growing at approximately 18% per annum and accounting for around 33% of sales for over the next five years. DHG s EPS is expected to reach VND6,730 for F2012, up 5% from 2011, and projected to grow at 13% per annum over DHG is projected to produce increasing cash from operation (CFO) from the current VND390bn, sufficiently funding investing and financing needs. Operations are expected to remain satisfactorily liquid, with current ratio averaging at 2.9x during DHG is projected to continue its low leverage capital structure with Debt-to- Equity expected to be at 4.5%. DHG serves markets with positive future growth. Positive factors including Vietnam s favorable demographic groups, increased healthcare awareness, growing population, and the government s favorable policies towards improving the supply and quality of needed medicines, are expected to outweigh perceived market risks, such as currency fluctuations and input cost inflation. Vietnam s pharmaceuticals consumption is expected to grow at about 15% over the next 5 years. Holding a significant 6% share in a highly fragmented market, coupled with a sound expansion plan expected to commence operation in late 2013, DHG is well-positioned to realize this growth opportunity. We derive the VND78,034 target price by weight-adjusting the results from FCFE and P/E Multiple valuations. DHG s stable operation, steady capital structure and high predictability of cash flow justify the use of FCFE, which receives 70% weight. Multiple valuation, receiving 30% weight, values DHG at aggregate level, placing the Company in relation to Southeast Asian and Vietnamese comparable peers. Key risks to the target price include delays in construction/equipping of the new factory, adverse exchange rate movements, input price inflation and fiercer-than-expected competition. We however expect DHG s strong operating cash, relatively sizeable market position and a seasoned management team will help the Company effectively manage these risks. Vietnam CFA Institute Research Challenge Page 3

4 SOCIAL RESPONSIBILITY Figure 3. Revenue breakdown % 7% In concert with enhancing financial performance, DHG also embraces sustainable social development. Improving overall life quality for workforce and their families, upholding industry standards towards protecting environment, ensuring gender equality, labor safety and continuous employee training are DHG s on-going activities. This leads to positive reputation and branding, making DHG a trusted partner in all dealings. 10% 43% BUSINESS DESCRIPTION Input resource Production Distribution 16% Antibiotics Analgesics 17% Digestive products ENT Vitamins-minerals Others Source: DHG annual report 2011 Figure 4. Production progress 20% 20% 80% 5% 95% 80% Source: Team synthesized Import raw material Domestic raw material generic patent Trading channel Hospital channel Four product groups account for over 85% of sales. They are Antibiotic medicines, Vitamins, ENT and Analgesic medications. These products are sold under multiple company-owned brands. Other medicines and non-medical products contribute approximately 15% to sales. Around 95% of DHG s medicines are popularly-used generic drugs with herbal medicines having started to be increasingly important as high-value, rich-margin product group. Herbal medicines, with inputs mostly internally sourced, currently account for 13% of sales and are on an upward trend. Raw materials are primarily overseas sourced. Over 80% of raw materials and almost 100% of Active Pharmaceutical Ingredients (APIs, key inputs) are imported. China, India and Europe are key import markets. While sales are mostly in local currency, this dependence on imported inputs makes DHG business vulnerable to foreign exchange risk. Quality assurance is constantly upheld: DHG s manufacturing activities and products are in full compliance with all required quality control/assurance standards. All finished products are subject to WHO-GMP reassessment process before packaging. Warehouses, both for raw materials and finished goods, also meet GDP (Good Distribution Practice) and GSP (Good Storage Practice) standards. DHG complies with ISO/IEC and GLP (Good Laboratory Practice) concerning its Lab operations. DHG has a nationwide distribution system. DHG s distribution network covers to drug store/hospital level in all provinces and cities in Vietnam. DHG s sales force is able to sell directly to 98% of state hospitals throughout Vietnam. The drug store channel generates 80% of sales with the balance coming from the hospital system. DHG is planning to consolidate its distribution system to ensure better resource allocation and more effective reporting mechanism. To improve overall management, DHG has recently invested in an ERP system, which is expected to enhance the Company s decision-making quality thanks to enjoying better integrated management information of all facets of the operation. (see appendix 16 and 18) New factory is under construction for future growth. DHG has started construction of a new factory that, together with the existing one, increases the Company s total annual capacity to 8 billion units from the current 3 billion. The new factory requires a VND676bn investment which will be financed totally by internal cash. In the context of the current factory operating at its full capacity, the new factory, which commences operation in late 2013, is of essence to prevent business breakdown and further ensure readiness for materializing growth plans. MANAGEMENT DHG s senior management team has a combined 150 years of experience, well-balanced in pharmaceutical production, marketing, R&D, financial and strategic management. Led by Mrs Pham Thi Viet Nga, BSc Pharm, Ph.D of Economics, over 32 years of experience including 25 years as DHG s CEO, the management has turned DHG around from near bankruptcy in late 1980 s to becoming Vietnam s leading pharmaceutical company to date. We believe that DHG s management shall continue to demonstrate their competence, capacity and strategy to grow the Company forwards. Vietnam CFA Institute Research Challenge Page 4

5 Figure 5. Pharmaceutical market forecast 100% Sales ($bn) Source: BMI forecast 80% 60% 40% % of GDP % 6% 5% 4% 3% Figure 6. Health care and drug expenditure per capita in some countries Heath Care Expenditure per Capita Drug Expenditure per Capita Source: WHO Figure 7. Demographic group 12.5% 15.0% 18.1% 27.4% 28.0% 27.4% 35.0% 33.9% 32.7% 20% 25.1% 23.1% 21.8% 0% Under Source: United Nations CUSTOMERS INDUSTRY OVERVIEW Doctors are DHG s primary customers. Except for Vitamins being OTC products, a majority of the Company s pharmaceuticals are prescription drugs and therefore, sales are largely dependent on whether doctors will prescribe them for patients. In Vietnam, prescription drugs cannot be directly advertised to consumers, but they can be marketed to health officers. DHG s sales force frequently calls on doctors, hospitals, wholesalers, pharmacists and healthcare centers. Organizing seminars introducing new drugs, sending samples to doctors and participating in medical meetings are regularly done to market the Company s products. INDUSTRY PROSPECT Favorable Forces Low per-capita medicine spending and large population provide room for future growth. Vietnam s per-capita medicine expenditure has steadily increased during at 16.5% CAGR. Per-capita spending has reached USD27,6 in 2011 (Vietnam s Ministry of Health). This figure is however significantly lower than the world s average of USD40 (BMI Report, Q3 2012). Vietnam s medicine spending is expected to increase to USD33.80 per capita by Vietnam has large and fast growing population, which is expected to increase from 87 million in 2011 to 100 million by 2019 (United Nation). This, combined with increased healthcare awareness and broader access to pharmaceuticals, creates a strong base for market growth. (appendix 12, 13) Demographics boost the industry. Vietnamese demography is aging. This favors the industry when older people tend to use more medicines. The proportion of the population whose age is higher than 55 was approximately 12.5% in However, this ratio will be 15% in 2015 and up to 18.2% in 2020 (United Nations forecast). Children under 4 years old which also form a large medicine user group are expected to maintain at 7.5-8% of a growing population for the next ten years. Polluted environment and unhealthy lifestyles lead to expanded uses of medicines. Growing cigarette and alcohol consumption, unhealthy diets, worsening air and water quality, deteriorating food quality and sedentary lifestyles have caused several lifestyle-related and noncommunicable diseases more common in Vietnam. Among many others, cancer has become a prevalent disease. In 2011 alone, around 150,000 people contracted cancers. This number is forecasted to be 200,000 people per year by 2015 and onwards. Besides, diabetes, notably the Type-2 diabetes, has become a national concern when approximately 3.2% of Vietnam s adult population, or 1.7 million people, currently contract diabetes. This figure is forecasted to reach to 3.5%, or 3.1 million people, by 2030 (IDF Diabetes Atlas). All above factors will lead to increasing uses of pharmaceuticals. (appendix 14) The government commits to further develop the pharmaceutical industry and improve healthcare. Domestic medicine production currently meets approximately 50% of the nation s demand. The government has announced its plan to improve the domestic supply of pharmaceuticals in order to meet 70% of total demand by 2015, and 80% by This plan aims at boosting the domestic production of essential drugs in order to cut prices, stabilize the supply and reduce dependence on foreign pharmaceutical imports. Corporate tax incentives and lower tariff for imported raw materials are also part of the government s plan to boost the domestic pharmaceutical industry. Unfavorable Forces Vietnam has heavy dependence on imported raw materials. Vietnam currently imports over 90% of needed raw materials to produce medicines. China, India and Europe are main import markets for Vietnamese medicine manufacturers. Domestically produced raw materials are not cost effective due to relatively small scale. R&D activities remain weak. Investment in R&D is low at almost all domestic pharmaceutical producers. Average R&D spending is just about 1-3% of sales, much lower than the normal 15% at multinational companies. Low R&D investment, due to lack of human resources and capital, Vietnam CFA Institute Research Challenge Page 5

6 Distribution Distribut ion Specific drug Figure 8. Competitive advantages Specific drug Higher natural Quality (less side effect) Lower price DHG domestic foreign Source: Team analysis Figure 9. Company positioning Higher specific level Traphaco Higher natural Quality (less side effect) Lower price DHG Traphaco Domesco Sanofi DHG Domesco Imexpharm Sanofi Novartis Merck & Co GSK Group OPC Source: Team s estimate Novartis Peizer Higher price Figure 10. DHG s competitive advantages Source: Team estimate has explained the domestic companies inability to introduce any patent medicines; they just compete in the generics segment instead. COMPETITIVE LANDSCAPE Vietnamese pharmaceutical industry is highly fragmented with the participation of over 200 companies. Domestic companies mostly compete in the generics segment while patent drugs are still the playground of multinational drug makers. Barrier of entry is fairly high because large investment capital and a number of industry s and government s standards (PIC/s, EU-GMP ) are required. Domestic companies focus mainly on generic medicines. Lack of essential facilities and technologies and low R&D investment have made generic medicine manufacturing a natural choice for domestic companies. Approximately 90% of domestically produced pharmaceuticals are generics. This segment witnesses a high level of competition. Broad distribution network and steady relationships with doctors, hospitals and wholesalers are key tools to compete. (appendix 15) Domestic companies are expected to tap more into the upscale medicine market. Commonly, foreign companies dominate the high value-added product sector, especially specific medicines due to lack of domestic supply of such and therefore set high prices. However, over next few years, many patents, especially those for specific medicines, will be expired. According to Pharma Report 2011 ( the patents of blockbuster drugs worth USD36bn will be expired in This presents huge opportunities for domestic companies to produce bio-equivalent generic versions of these specific drugs. When patents expire, domestic companies can buy compounds from the patent holders to produce their own products. This will help increase the supply of specific medicines at more affordable prices for patients. Domestic versus foreign companies Government policies give domestic companies some advantages over foreign players. Regulated discrepancies in tariff and distribution right and corporate tax incentives have given domestic companies an edge over their foreign competitors. Imported raw materials are taxed at 0% while finished product imports are imposed 5% rate. Foreign companies are still barred from distributing their products directly to customers. In addition, domestic pharmaceutical companies are subject to 15-20% income tax, 5-10% lower than the 25% statutory tax rate. Distribution network is unparalleled advantage that domestic companies enjoy over their foreign competitors. Over the past years, taking advantage of the regulation that bars foreign companies from directly importing their products to Vietnam and directly distributing goods to customers, domestic companies have fully widened their distribution network. Along the way, they have also created steady relationships with hospitals and drug stores across the country. These are meaningful intangible assets enjoyed by domestic companies. COMPANY COMPETITIVE ADVANTAGES AND POSITIONING Possessing many well-known brands and a diversified product portfolio is one of DHG s most important advantages. Brands such as Hapacol, Unikid, Eyelight, Spivital have been long recognized as high quality, gaining full trust and awareness by customers. With portfolio of over 200 products, DHG is able to meet a wide range of treatment needs. DHG s production scale is also a notable advantage. Being the largest domestic pharmaceutical manufacturer by capacity, currently 3 billion units per year, DHG will be a much larger producer when the new factory is put into operation. DHG s combined capacity will reach 8 billion units per year, allowing the Company to enjoy economies of scale and scope. Of all domestic companies, DHG has relatively wider distribution networks. The Company s sales agents have reached over 20,000 drug stores across Vietnam. DHG is also able to sell products directly to 98% of all state hospitals in Vietnam. Nationwide coverage and Vietnam CFA Institute Research Challenge Page 6

7 Figure 11. Net sales and revenue growth rate 8,000 6,000 4,000 2,000 1, ,000 4,000 3,000 2,000 1, % 40% 30% 20% 10% 0% Net sales Current Assets Net Income Gross Margin Current Ratio (x) Revenue Growth Rate EBITDA Net Margin Return on Equity Return on Assets Return in invested capital 4.0x 3.0x 2.0x 1.0x 0.0x Current Liabilities Cash Ratio (x) 25% 20% 15% 10% 5% 0% Source: DHG annual reports and team estimate Figure 12. Profitability ratios Source: DHG annual reports and team estimate Figure 13. Return ratios Source: DHG annual reports and team estimate Figure 14. Liquidity ratios Source: DHG annual reports and team estimate 60% 40% 20% 0% steady relationships with customers help better strengthen the Company s market position. (appendix 16) DHG is among a few companies in Vietnam pioneering in producing and marketing drugs extracted from herbs and natural sources. Herbal medicines, thanks to their few-to-no side effects, are increasingly perceived by customers as good alternatives to chemical medicines. DHG has developed its own herbal material zones and produced several herbal medications that are increasingly accepted by customers. Currently holding 6% market share, DHG is expected to increase its share in a growing market due to its dominant production scale, reputation and extensive distribution network. FINANCIAL ANALYSIS AND PROJECTION HISTORICAL FINANCIAL ANALYSIS DHG has showed a remarkable improvement in financial performance over the recent three years, mostly through revenue growth and effective control of operating expenses. This has led to increasingly higher ROE and EPS in than those in Earnings quality has remained satisfactory when annual CFO has equaled 85% of net income. Operations have generated significant cash which was sufficient to finance CAPEX investments and cash dividends. DHG has taken minimal financial leverage when Debt-to-Equity during averaged at 6%. In addition, DHG has solely focused on its core operations of manufacturing and trading pharmaceuticals. Core operations have consistently accounted for over 95% of total sales. The Company has not invested in any long-term financial instruments or real estate ventures. DHG recorded VND2,039bn sales for Q1-Q and earned a 48.6% gross margin sales and profit margin both increased y.o.y by 17.1% and 1.4% respectively. As of Q3 2012, cash and cash equivalent was VND602.5bn, approximately up 33% y.o.y. This strong cash holding guarantees the planned disbursements to the new factory project without using bank loans. Financial Performance Sales stably grew at approximately 18% per annum. DHG s business has shown to be recession-proof when the Company constantly gained increasing sales despite of economic downturn in Vietnam. DHG generated VND2,490bn sales for 2011, almost linearly up from VND1,269bn in DHG s sales growth was driven by strong market demand, broad distribution network and continued success of product branding. (appendix 19) Gross margin, even though remaining relatively high, has slightly squeezed during Gross margin in 2011 was 48.5%, down from 53.25% in This margin reduction was caused by higher competition level, input cost inflation (primarily due to VND devaluation) and pricing ceiling regulation set by the government in its effort to curb inflation during this period. Selling expenses have been effectively managed in the context of growing sales. By pushing sales through company-owned distribution facilities and internal sales force rather than distribution contractors, DHG has succeeded in containing selling expenses at around 23% of sales since This was a remarkable improvement as compared to 35% in 2007 and Business has remained highly profitable. DHG generated VND415bn net profit for 2011, presenting a 9% growth from Net profit margin has been notably richer since 2009 than that in Net margin in was 19-23%, almost doubled that in Financial Position Liquidity has been satisfactorily sufficient. DHG s current ratio and quick ratio during averaged at 2.6x and 1.6x respectively, which is higher than industry average. The high quick ratio has enabled DHG to fully meet all short-term obligations when due. Balance sheet has been solidly healthy due to low leverage. DHG has financed its assets primarily by equity capital. Equity-to-Asset was in the region of 70% during Debtto-Equity had been low at approximately 6% for the same period. By maintaining a balance sheet that is mostly internally-funded, DHG is relatively more shock-resistant than its peers. Vietnam CFA Institute Research Challenge Page 7

8 Thousands ,000 12,000 10,000 8,000 6,000 4,000 2,000 6,000 4,000 2, Figure 15. Asset and Liabilities Total Assets Total Liabilities Interest-bearing Debt to Equity (%) Source: DHG annual reports and team estimate Figure 16. Cash cycle days EPS adjusted 170 Source: Team estimate Figure 17. Expected EPS and DPS Source: Team s estimate 180 DPS adjusted 10% 8% 6% 4% 2% 0% F2012 F2013 F2014 F2015 F2016 F2017 A/R (Net) DSO Inventory days AP Days Outstanding Working Capital Cycle (Days) 11,956 Working capital has been well managed: DHG s cash cycle has decreased sharply from 180 days in 2008 to 149 days in This was due to decrease in Days of Inventory on Hand (DIO), down to 125 days from 162 days, meanwhile Days of Sale Outstanding (DSO) and Days of Payables were stable cash cycle increased to 161 days, driven by increase in finished goods category. This was however well justified by the level of year-over-year sales growth in 2011 compared to that in Sales growth in 2011 was 22.4%, which was significantly higher than the 16.5% in Cash Flows Operations have been significantly cash positive. Driven by high profitability and effective working capital management, DHG s operations have generated significant cash, fully sufficient to fund investing activities and cash dividends. The Company produced VND307bn CFO in 2011, well covering the VND299bn CAPEX in the same year. DHG has paid out, on average, 36% of annual net income as cash dividends during KEY ASSUMPTIONS FOR PROJECTION AND ESTIMATE Sales growth: Sales are expected to maintain 16-17% growth over before leveling down to 14% in later years. Year-to-Q sales were VND2,039bn, 17.1% y.o.y increase. We project DHG will conclude 2012 at approximately VND2,888bn sales, presenting a 16% y.o.y growth. DHG is projected to sustain the 16% growth in 2014, driven by both price increase and change in product mix towards increasing the weight of higher value products. Sales in 2014 and 2015 are expected to grow at 18-19% primarily thanks to volume increase when the new factory has been in operation. Sales in later years are forecasted to level down to 14% given the sizeable base of the business and anticipated tougher competition. By product line, Antibiotic medicines group is expected to continue its key role in generating sales over the projection period, contributing approximately 33% to total sales and annually growing at 18%. The remaining 67% is expected to come fairly equally from Vitamins, ENT, Analgesic medicines and other products. We attribute sales growth to both price increase, that tracks projected medium-term inflation of 7-12% per annum and volume growth which is about 10-12% in (when the new factory has smoothly operated) and 5-8% in later years. (See Appendix No.5 and No.20) Gross margin: Gross margin is forecasted to slightly decrease due to expected higher competition and possible further inflation in input prices. DHG earned 48.6% on its YTD sales. To be conservative, we project full 2012 gross margin will be 46%. Going forward, we project gross margin to be 45% in and then slightly reduce to 44.5% in 2015 before leveling down to 43-44% in later years. Overall, average projected gross margin during the projection horizon is 5-7% lower than historical average. This, in our view, is driven by higher competition level when foreign companies are allowed to fully penetrate the market under WTO commitments and anticipated VND devaluation. Selling expenses: We project selling expenses as percentage of sales to be 23.5% in , which is slightly higher than the 23.2% historical average. In later years, we project a higher level of selling expenses, averaging at 24.5% of sales, caused by expanded promotion activities and increase sales force to realize the projected sales growth. Effective tax rate: DHG will continue to enjoy 50% cut from the statutory 25% corporate income tax (CIT) for all existing production facilities during The new factory s operation, which is projected to contribute 30% to total pretax profit in 2014 and linearly up to 60% in 2017, is subject to 100% CIT cut for the first 5 operating years and 50% cut for the next 5 years. Other activities sales are taxed at normal rate of 25%. This leads to our projected effective CIT rate to be 14% in , 17.5% in 2014, 15% in 2015 and then down to 12.5% and 10% for 2015 and 2016 respectively. Working capital items: DSO is expected to be 53 in With anticipated broader customer base to grow sales, we conservatively assume DSO to be in later years, which is 3-8 days longer than historical average. We expect DIO to follow the same pattern as DSO over the next 5 years. DIO in 2012 is projected to be 140 (4 days longer than historical average) and straight up from 145 to 160 days during Vietnam CFA Institute Research Challenge Page 8

9 % 30% 20% 10% 0% Figure 18. Non-production cost ratios Selling Expense (% of Sales) G&A Expense (% of Sales) Tax Margin Source: Team s estimate We project Days of Payables to be in the range of days, a conservative assumption given the fact that historical average was 35 days. Capital Expenditure: Capital Expenditure falls into two categories: Growth CAPEX (the new factory) and Maintenance CAPEX. As of year-end 2011, DHG has disbursed VND73.7bn to construct the new factory. Growth CAPEX over is therefore projected to be approximately VND120, 270 and 100bn accordingly. We project that DHG will spend around VND88bn per year in Maintenance CAPEX (roughly same as historical average) to maintain the satisfactory working conditions of all existing factories. Retention ratio: We project DHG to retain 80-90% of its earnings during to duly meet the Growth CAPEX requirements while maintaining the desired liquidity level. The Company is expected to retain less in immediate later years before reaching the projected longterm retention ratio of 40% of annual net earnings. VALUATION Table 2. Summary of valuation All figures in VND Target price Weight FCFE Valuation 79,690 70% Multiple Valuation (PE) 74,171 30% Target Price Current price (Nov. 13, 2012) % Upside (by Dec 31, 2013) 78,034 65, % Source: Team estimate Figure 19. Target price distribution Monte Carlo Simulation DCF Price Distribition (1681 observations) 85% Probability: Target price > Current price (Nov 13, 2012) Using g and Re as sensitive variables Source: Team s estimate VND'000 We use FCFE and P/E Multiple Valuation to value DHG. The weighted average target price is VND78,034. We project the current price will converge to the target price by year-end 2013, which then offers a 19.14% upside. FCFE valuation produces VND79,690 per share by year-end (appendix 8) We choose FCFE over other DCF methods because of DHG s low-leverage capital structure, stable operation and high predictability of financial results. We employ 8.8% risk premium, 10.1% risk-free rate (10-year government bond yield) and 0.62 Adjusted Beta, all provided by Bloomberg, to arrive at the required rate of return on Equity of 15.6%. We derive DHG s Perpetual Growth Rate of 8% from the Company s expected long-term retention ratio of 40% and ROE of 20%. P/E Multiple method shows VND74,171 per share by year-end (appendix 9) We place DHG in relation to its peers in Vietnam and Indonesia and Malaysia to arrive at the justified P/E of 10 (75% weight to Vietnam s pharmaceutical P/E average and 25% to Indonesia/Malaysia average). We assign 70% and 30% weight to the FCFE and P/E Multiple results respectively to determine the target price. P/E Multiple receives less weight due to the difficulties to find a set of exactly comparable companies. Meanwhile with DHG s operation and earnings being stable and the dividend payout policy being fairly predictable, FCFE warrants a higher weight. KEY RISK ASSESSMENT Input price and VND devaluation risks: Imported inputs, mostly APIs and pharmaceutical chemicals/additives, make up 60-80% of COGS. Therefore, any unexpected surge in input prices may squeeze DHG s margins. Input price inflation may be caused by increase in production costs in import markets and/or VND devaluation. Mitigation: DHG actively sources all of its materials from major suppliers who can ensure continuity in any market conditions. As a well-established company in the industry, DHG has created and maintained good relationships with a broad portfolio of suppliers through which the Company can obtain updated information on price movements. This would allow DHG to tactically adjust its purchase plans. In addition, DHG s good relationships with banks allow the Company to buy USD and EUR at most reasonable prices, even in scarcity times and open L/Cs with no collaterals. Vietnam CFA Institute Research Challenge Page 9

10 New factory delay risk: As the current manufacturing facilities are running at full capacity, operating the new factory as scheduled becomes critical to business continuity and future growth. Therefore, any delays in construction/equipping of the new factory could present operational risks. Mitigation: All preparatory work for the new factory has been completed and the construction is ongoing. As of Q3 2012, the Company has disbursed over VND100bn of VND676bn total investment. With cash and cash equivalent by Q posted VND603bn while financial obligations being trivial, we are confident that the new factory s construction/equipping will be satisfactorily funded and operation will start as planned. Competition risk: DHG s business could in future be exposed to tougher competition, mostly coming from foreign pharmaceutical companies which are allowed to further penetrate the market under WTO commitments. Mitigation: Significant market position, nationwide distribution network, good brand-name and competent management team are expected to enable DHG to sustain and further develop its current leading position in the foreseeable future. Legal risk: Laws and regulations governing the pharmaceutical industry are still opaque and subject to unexpected changes. This may lead to potential legal risks when it comes to laws interpretation and application. Mitigation: DHG always ensures that its corporate charter/documents to stay legally updated. The Company, once a year, pre-check tax balance with the tax office before having its financial statements audited. DHG also ensures to have all contracts and agreements reviewed by legal experts before signing. These practices help minimize legal issues. Vietnam CFA Institute Research Challenge Page 10

11 APPENDICES APPENDIX 1: Income statement Annual Income Statement (All figures in USD) F2012 F2013 F2014 F2015 F2016 F2017 ACTUAL PROJECTED Net sales 1,269,280 1,485,464 1,746,022 2,034,525 2,490,880 2,883,929 3,344,919 3,954,688 4,684,008 5,455,235 6,225,838 Cost of Goods Sold (601,278) (694,445) (822,446) (1,015,993) (1,282,117) (1,557,322) (1,839,706) (2,175,078) (2,599,624) (3,054,932) (3,548,727) Gross Profits 668, , ,576 1,018,532 1,208,763 1,326,607 1,505,214 1,779,609 2,084,384 2,400,303 2,677,110 SG&A (529,507) (625,423) (523,234) (618,574) (744,051) (879,598) (1,020,200) (1,245,727) (1,498,883) (1,718,399) (1,930,010) EBIT 138, , , , , , , , , , ,101 Depreciation 24,054 7,181 29,779 41,463 50,147 53,568 62, , , , ,709 EBITDA 162, , , , , , , , , , ,809 Interest Income 3,022 16,391 27,260 36,238 41,907 26,909 35,616 43,905 51,859 49,696 52,534 Other Financial Income 192 5,938 4,034 4,328 6,988 8,091 9,384 11,095 13,141 15,304 17,466 Financial income 3,214 22,329 31,294 40,566 48,895 35,000 45,000 55,000 65,000 65,000 70,000 Interest Expense (15,393) (5,216) (3,389) (2,010) (2,038) (2,596) (3,914) (6,407) (5,480) (4,910) (5,603) Other financial Expense (1,897) (33,137) (20,208) (1,399) (5,144) (3,788) (4,393) (5,194) (6,152) (7,165) (8,177) Financial expenses (17,290) (38,353) (23,597) (3,409) (7,182) (6,383) (8,307) (11,601) (11,632) (12,075) (13,780) Other income 2,674 1,530 14,224 9,233 9,933 11,500 13,339 15,770 18,679 21,754 24,827 Other expenses - (6,077) (12,674) (12,204) (25,416) 20,000 17,000 20,099 23,806 27,725 31,642 Other profits/loss (11,402) (20,571) 9,247 34,186 26,230 60,117 67,032 79,269 95, , ,689 Pre-tax Income 127, , , , , , , , , , ,789 Taxes - (16,163) (52,519) (52,982) (75,415) (70,905) (77,385) (107,302) (102,203) (98,039) (85,979) Net Income 127, , , , , , , , , , ,810 Source: Company Report and Team's Estimate Vietnam CFA Institute Research Challenge Page 11

12 APPENDIX 2: Balance Sheet F2012 F2013 F2014 F2015 F2016 F2017 Balance sheet (All figures in VND'000,000) ACTUAL PROJECTED Cash 187, , , , , , , , , , ,901 Account receivables 237, , , , , , , , , ,588 1,023,425 Inventory 232, , , , , , , ,868 1,103,950 1,314,039 1,555,607 Other current assets 16,942 44,515 55, , , , , , , , ,462 Current Assets 674, ,527 1,212,468 1,442,034 1,490,692 1,757,013 1,939,710 2,381,832 2,819,127 3,335,827 3,896,395 Gross Fixed assets 287, , , , , ,479 1,252,087 1,431,655 1,557,430 1,671,970 1,753,382 Less accumulated depreciati 57,583 84, , , , , , , , , ,939 Net fixed assets 229, , , , , , , , , , ,443 Other Long term investments 38,432 72,869 74,062 70,167 45,562 52,751 61,184 72,337 85,678 99, ,880 Total Long term Assets 268, , , , , ,890 1,003,342 1,067,057 1,067,007 1,045, ,323 Total Assets 942,861 1,081,782 1,521,973 1,819,735 1,995,707 2,430,903 2,943,052 3,448,890 3,886,134 4,381,351 4,879,718 Short-term borrowings 43,430 8,455 73,980 12,802 21,116 28,839 43,484 71,184 60,892 54,552 62,258 Account payables 57,171 67,746 71,353 86, , , , , , , ,064 Other current liabilities 190, , , , , , , , , , ,641 Current Liabilities 291, , , , , , , , ,419 1,117,501 1,228,963 LT liabilities ,193 14,242 59,141 58,224 58,224 58,224 58,224 58,224 58,224 58,224 Total Long-Term Liabilities ,193 14,242 59,141 58,224 58,224 58,224 58,224 58,224 58,224 58,224 Total Liabilities 292, , , , , , , ,890 1,023,643 1,175,725 1,287,188 Paid in capital 578, , , , , , , , , , ,764 Undistributed Earnings 71, , , , ,783 1,070,035 1,497,229 1,851,324 2,198,814 2,541,950 2,928,855 Other funds/reserve - 3,185 7,781 8,716 11,911 11,911 11,911 11,911 11,911 11,911 11,911 Total Stockholders' Equity 650, ,125 1,025,814 1,289,038 1,393,458 1,733,710 2,160,905 2,515,000 2,862,490 3,205,625 3,592,530 Liabilities and Equity 942,861 1,081,782 1,521,973 1,819,735 1,995,707 2,430,903 2,943,052 3,448,890 3,886,133 4,381,351 4,879,718 Vietnam CFA Institute Research Challenge Page 12

13 APPENDIX 3: Cash flow Statement Cashflow (All figures in VND'000,000) F2012 F2013 F2014 F2015 F2016 F2017 ACTUAL PROJECTED Cash Flows from Operating Activities: Net Income 128, , , , , , , , , ,810 Adjustments to Reconcile NI to cash provided by oper Depreciation and Amortization 28,520 29,779 41,463 51,970 53,568 62, , , , ,709 Changes in Working Capital (inc) decrease in AR 21,012 (33,684) (56,265) (32,014) (80,029) (85,267) (146,057) (184,053) (107,450) (81,837) (inc) decrease in Inventory (75,838) 1,505 (40,368) (167,092) (83,137) (133,513) (163,026) (210,082) (210,089) (241,568) (inc) decrease in other current assets (27,573) (10,601) (90,580) (24,987) (25,582) (45,669) (56,022) (72,402) (81,605) (92,500) Increase (decrease) in AP 10,575 3,607 14,938 37,327 17,181 10,410 27,565 13,527 33,680 17,082 Increase (decrease) in other current liabilitie 100,266 45,320 35,879 26,827 70,040 59,901 96,477 86, ,742 86,674 Net Cash Provided by Operating Activities Cash Flows Provided by Investing Activities New factory Ongoing fixed assets Other Capital expenditures Net Cash Provided by Investing Activities Cash Flows Provided by Financing Activities Increase (decrease) in S/T Debt Dividend paid Net Cash Provided by Financing Activities Net Increase/(Decrease) in Cash Cash Beginning of Period Cash End of Period 185, , , , , , , , , ,371 (73,700) (120,000) (270,000) (100,000) (60,000) (40,000) - (19,761) (41,149) (119,714) (180,812) (95,254) (113,608) (79,568) (65,775) (74,540) (81,412) (34,437) (1,192) 3,894 24,605 (7,189) (8,432) (11,154) (13,340) (14,107) (14,096) (54,198) (42,341) (115,820) (229,907) (222,443) (392,040) (190,722) (139,115) (128,647) (95,508) (34,975) 65,524 (61,177) 8,314 7,723 14,645 27,700 (10,292) (6,340) 7,706 (69,962) (30,018) (66,880) (261,400) (95,969) (47,466) (151,755) (231,660) (343,135) (386,905) (104,937) 35,506 (128,058) (253,087) (88,245) (32,821) (124,055) (241,952) (349,475) (379,199) 26, ,160 42,353 (175,435) 77,572 (81,751) 77,018 (29,242) 117, , , , , , , , , , , , , , , , , , , , , ,901 Vietnam CFA Institute Research Challenge Page 13

14 APPENDIX 4: Master assumption Historical Average ( ) ASSUMPTIONS REVENUES 15.8% Vitamin (YoY % change) 14.5% 16.6% 21.0% 18.8% 16.6% 15.6% 19.9% ETN (YoY % change) 14.3% 16.6% 19.9% 18.8% 16.6% 16.6% 17.2% Antibiotic (YoY % change) 13.4% 15.0% 18.2% 18.2% 15.5% 13.4% 7.5% Analgesic (YoY % change) 13.2% 14.5% 18.8% 17.7% 14.5% 12.4% 14.1% Other medicines Sales (YoY % change) 17.6% 18.7% 23.2% 23.2% 19.8% 17.6% Non-medical Sales/ total Sales 19.0% 19.0% 18.0% 17.5% 17.5% 17.0% 48.53% GROSS MARGIN 46.0% 45.0% 45.0% 44.5% 44.0% 43.0% 23.19% SELLING EXPENSE/SALES 23.5% 23.5% 24.5% 25.0% 24.5% 24.0% 6.87% G&A EXPENSES/SALES 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% WORKING CAPITAL 52 Accounts Receiveable (days of sales) Inventories (days of COGS) Other Current Assets (days of CoGS) Accounts Payable (days of CoGS) Other Current Liabilities (days of CoGS) % Short-term borrowings (% of Sales) 1.0% 1.3% 1.8% 1.3% 1.0% 1.0% Capital Expenditure Capex 215, , , , ,540 81,412 New land purchase 12,000 8,608 9,568 10,257 11,022 11,843 New building 30,000 30,000 25,000 16,282 18,782 20,410 Furniture, Fixtures & Equipment (FF&E) 35,000 35,000 30,000 24,901 27,901 30,391 Other fixed capital investments 18,254 40,000 15,000 14,335 16,835 18,769 New Factory Investment 120, , ,000 60,000 40,000 0 All figures in VND'000,000 Debt financing 8.3% Short-term borrowing cost (%) 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% Equity financing 70.4% Retention ratio 78.0% 90.0% 70.0% 60.0% 50.0% 50.0% Corporation Tax 13.5% Effective tax rate 14.0% 14.0% 17.5% 15.0% 12.5% 10.0% Statutory tax for core operations Existing factory 12.5% 12.5% 25.0% 25.0% 25.0% 25.0% New factory 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other activities 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% Contribution to Pre-tax Income % of pretax income from existing factory 88.1% 87.9% 57.1% 45.9% 36.9% 26.9% % of pretax income from new factory 0.0% 0.0% 30.0% 40.0% 50.0% 60.0% % of pretax income from other activities 11.9% 12.1% 12.9% 14.1% 13.1% 13.1% Vietnam CFA Institute Research Challenge Page 14

15 APPENDIX 5: Revenue Projection Fiscal year E 2013E 2014E 2015E 2016E 2017E All figures in VND'000,000 Avg selling price per unit growth rate 9.13% 17.26% 9.00% 8.00% 8.00% 7.00% 7.00% 7.00% Volume growth rate 1.09% 3.23% 5.00% 8.00% 12.00% 11.00% 9.00% 8.00% Sales Growth rate 10.32% 21.05% 14.45% 16.64% 20.96% 18.77% 16.63% 15.56% Vitamin 171, , , , , , , ,057 Avg selling price per unit growth rate 6.67% 12.24% 11.00% 11.00% 9.00% 9.00% 9.00% 9.00% Volume growth rate 2.85% 16.85% 3.00% 5.00% 10.00% 9.00% 7.00% 7.00% Sales Growth rate 9.70% 31.15% 14.33% 16.55% 19.90% 18.81% 16.63% 16.63% ETN 260, , , , , , , ,480 Avg selling price per unit growth rate 9.98% 6.24% 9.00% 7.50% 5.50% 5.50% 5.00% 5.00% Volume growth rate 4.69% 12.24% 4.00% 7.00% 12.00% 12.00% 10.00% 8.00% Sales Growth rate 15.13% 19.24% 13.36% 15.03% 18.16% 18.16% 15.50% 13.40% Antibiotic 738, , ,568 1,147,453 1,355,830 1,602,049 1,850,366 2,098,315 Avg selling price per unit growth rate 2.38% 9.16% 11.00% 9.00% 8.00% 8.00% 7.00% 7.00% Volume growth rate 1.28% 2.11% 2.00% 5.00% 10.00% 9.00% 7.00% 5.00% Sales Growth rate 3.69% 11.46% 13.22% 14.45% 18.80% 17.72% 14.49% 12.35% Analgesic 253, , , , , , , ,348 Avg selling price per unit growth rate 29.73% 8.31% 12.00% 12.00% 12.00% 12.00% 12.00% 12.00% Volume growth rate % 4.07% 5.00% 6.00% 10.00% 10.00% 7.00% 5.00% Sales Growth rate 15.94% 12.71% 17.60% 18.72% 23.20% 23.20% 19.84% 17.60% Other medicines 296, , , , , , , ,503 Medicine sales 1,718,000 2,043,000 2,335,233 2,708,508 3,241,787 3,863,033 4,499,068 5,165,703 Growth rate 12.07% 18.92% 14.30% 15.98% 19.69% 19.16% 16.46% 14.82% Non-medical Sales/Total Revenue 15.57% 17.95% 19.00% 19.00% 18.00% 17.50% 17.50% 17.00% Non-medical Sales 317, , , , , , ,348 1,058,036 Total Revenue 2,035,000 2,490,000 2,883,004 3,343,837 3,953,398 4,682,465 5,453,416 6,223,739 CAGR 16.49% 22.36% 15.78% 15.98% 18.23% 18.44% 16.46% 14.13% Vietnam CFA Institute Research Challenge Page 15

16 APPENDIX 6: Fixed Assets and Depreciation Projection F2012 F2013 F2014 F2015 F2016 F2017 Existing Fixed Assets All figures in VND'000,000 La nd 107, , , , , ,057 Bui l di ngs 102, , , , , ,880 FF&E 179, , , , , ,808 Others 143, , , , , ,524 In proces s 46,746 40,000 55,000 45,000 40,000 35,000 Ongoi ng 579, , , , ,730 1,008,270 New fa ctory 73, , , , , ,700 Total Existing Assets 653, ,479 1,252,087 1,431,655 1,557,430 1,671,970 New Additions to Assets La nd 12,000 8,608 9,568 10,257 11,022 11,843 Bui l di ngs 30,000 30,000 25,000 16,282 18,782 20,410 FFE 35,000 35,000 30,000 24,901 27,901 30,391 Others 25,000 25,000 25,000 19,335 21,835 23,769 In proces s (6,746) 15,000 (10,000) (5,000) (5,000) (5,000) Ongoi ng 95, ,608 79,568 65,775 74,540 81,412 New fa ctory 120, , ,000 60,000 40,000 Total Additions to Assets 215, , , , ,540 81,412 Total Assets La nd 119, , , , , ,900 Bui l di ngs 132, , , , , ,290 FF&E 214, , , , , ,199 Others 168, , , , , ,292 In proces s 40,000 55,000 45,000 40,000 35,000 30,000 Ongoi ng 674, , , ,730 1,008,270 1,089,682 New fa ctory 193, , , , , ,700 Total Existing Assets 868,479 1,252,087 1,431,655 1,557,430 1,671,970 1,753,382 Vietnam CFA Institute Research Challenge Page 16

17 F2012 F2013 F2014 F2015 F2016 F2017 Average Depreciation Period (yrs) All figures in VND'000,000 Land Bui l di ngs FF&E Others New fa ctory Annual Depreciation La nd 1,000 1,000 1,000 1,000 1,000 1,000 Bui l di ngs 11,068 13,568 15,651 17,008 18,573 20,274 FF&E 23,779 27,667 31,001 33,768 36,868 40,244 Others 17,721 20,353 22,985 25,020 27,318 29,820 New fa ctory 56,370 62,370 66,370 66,370 Total Annual Depreciation 53,568 62, , , , ,709 Accumulated Depreciation La nd 5,079 6,079 7,079 8,079 9,079 10,079 Bui l di ngs 41,180 54,748 70,400 87, , ,255 FF&E 119, , , , , ,931 Others 81, , , , , ,193 New fa ctory 56, , , ,480 Total Accumulated Depreciation 247, , , , , ,939 Net Balance La nd 114, , , , , ,821 Bui l di ngs 91, , , , , ,035 FF&E 94, , ,955 92,088 83,122 73,268 Others 86,656 91,303 93,318 87,634 82,151 76,099 i n proces s 40,000 55,000 45,000 40,000 35,000 30,000 New fa ctory 193, , , , , ,220 Total Balance 621, , , , , ,443 Vietnam CFA Institute Research Challenge Page 17

18 APPENDIX 7: Financial Ratios F2012 F2013 F2014 F2015 F2016 F2017 Return on Equity 19.10% 41.40% 32.93% 30.98% 27.90% 24.38% 21.64% 21.54% 22.62% 22.77% Return on Assets 12.73% 27.43% 22.81% 21.78% 19.71% 17.67% 15.83% 15.79% 16.60% 16.71% Return in invested capital 23.63% 44.30% 33.31% 34.22% 31.51% 27.61% 27.59% 26.31% 26.91% 26.17% Total Gross Margin 52.63% 53.25% 52.90% 50.06% 48.53% 46.00% 45.00% 45.00% 44.50% 44.00% 43.00% SG&A / Net Sales 41.72% 42.10% 29.97% 30.40% 29.87% 30.50% 30.50% 31.50% 32.00% 31.50% 31.00% EBITDA margin 12.81% 11.63% 24.63% 21.70% 20.67% 17.36% 16.37% 16.71% 15.47% 15.25% 14.53% Operating Margin 10.91% 11.15% 22.93% 19.66% 18.66% 15.50% 14.50% 13.50% 12.50% 12.50% 12.00% Net Margin 10.01% 8.67% 20.45% 18.73% 16.68% 15.13% 14.19% 12.79% 12.36% 12.58% 12.43% Effective tax rate 0.00% 11.14% 12.82% 12.20% 15.36% 13.98% 14.02% 17.50% 15.00% 12.50% 10.00% Basic Weighted Average Share EPS adjusted (VND) 1,958 1,985 5,501 5,872 6,401 6,720 7,312 7,792 8,922 10,572 11,920 DPS adjusted (VND) 230 1, ,030 4,027 1, ,338 3,569 5,286 5,960 Growth Rates (Yr/Yr) Revenue - Total 17.03% 17.54% 16.52% 22.43% 15.78% 15.98% 18.23% 18.44% 16.47% 14.13% Operating income 19.57% % -0.10% 16.19% -3.81% 8.50% 10.08% 9.67% 16.47% 9.56% Net Income 1.39% % 6.75% 9.02% 4.98% 8.81% 6.57% 14.49% 18.50% 12.76% F2012 F2013 F2014 F2015 F2016 F2017 Efficiency and Profitability Ratios Asset Turnover 1.47x 1.34x 1.22x 1.31x 1.36x 1.35x 1.24x 1.28x 1.32x 1.34x Fixed Asset Turnover 6.52x 7.58x 7.49x 6.50x 5.34x 4.28x 4.08x 4.74x 5.66x 6.86x A/R (Net) DSO AR Turnover 5.3x 6.9x 7.0x 6.6x 7.4x 6.9x 6.6x 6.1x 5.6x 5.8x 6.1x Inventory turnover 2.59x 2.25x 2.68x 2.93x 2.49x 2.61x 2.52x 2.43x 2.35x 2.32x 2.28x Inventory days PP&E, net/ sales 22.7% 20.9% 20.0% 22.1% 26.2% 30.1% 37.4% 36.2% 33.2% 30.6% 28.2% AP Days Outstanding AP/Sales 4.5% 4.6% 4.1% 4.2% 5.0% 4.9% 4.5% 4.5% 4.1% 4.1% 3.9% Net (non-cash) working capital 238, , , , , , ,366 1,037,428 1,403,919 1,644,641 1,956,789 Change in Working Capital -28,442-6, , , , , , , , ,148 Net Working Capital % of Revenu 18.8% 14.2% 11.7% 16.7% 20.1% 20.9% 23.8% 26.2% 30.0% 30.1% 31.4% Working Capital Cycle (Days) Leverage and Liquidity Ratios Debt to Equity (%) 6.8% 3.4% 8.6% 5.6% 5.7% 5.0% 4.7% 5.1% 4.2% 3.5% 3.4% Current Ratio (x) 2.31x 2.13x 2.52x 3.06x 2.74x 2.75x 2.68x 2.72x 2.92x 2.99x 3.17x Acid Test Ratio (x) 1.46x 1.17x 1.77x 2.01x 1.48x 1.51x 1.34x 1.36x 1.39x 1.40x 1.46x Vietnam CFA Institute Research Challenge Page 18

19 APPENDIX 8: FCFE Valuation Model Calculate Requrires Rate of Return on Equity (Re) Ri s k-free ra te 10.1% By Bloomberg Ri s k Premi um 8.8% By Bloomberg Beta 0.6 Last 3-years adjusted Beta by Bloomberg Re 15.6% Calculate perpetual growth rate Some companies in Indonesia and Malaysia Retention ratio (average last 5 years) ROE (average last 5 years) Growth ra te Wei ght Taisho Pharma Corp. (Indonesia) 24.0% 43.5% 10.4% Darya Varia Laboratoria Ltd (Indonesia) 63.9% 14.6% 9.4% Pharmaniaga Berhad Corp. (Malaysia) 57.8% 13.0% 7.5% CCM Doupharma Ltd (Malaysia) 24.8% 21.0% 5.2% Average 8.1% 40% Company expected Expected l ong-term ROE Expected Retention Ra tio Expected Perpetual Growth rate 20% 40% 8.00% 60% Perpetual Growth rate 8.05% (All figures in VND'000,000) Fiscal year Net i ncome 474, , , , ,810 Depreci a tion a nd Amortiza tion 62, , , , ,709 Cha nge i n Worki ng Ca pi tal (194,138) (241,063) (366,491) (240,722) (312,148) Ca pi tal Expendi ture (392,040) (190,722) (139,115) (128,647) (95,508) Net Borrowi ngs 14,645 27,700 (10,292) (6,340) 7,706 FCFE (34,285) 228, , , ,569 Di s count Fa ctor PV (34,285) 197, , , ,119 Total PV of Free Cash Flow to Equity 5,173,057 Number of shares Outstanding (million) Target Price (VND) 79,690 Vietnam CFA Institute Research Challenge Page 19

20 APPENDIX 9: P/E Multiple Valuation 1. Calculate avarage P/E of comparable companies in Indonesia, Malaysia and Vietnam Indonesia and Malaysia Taisho Pharma Corp. (Indonesia) by Bloomberg Darya Varia Laboratoria Ltd (Indonesia) by Bloomberg Pharmaniaga Berhad Corp. (Malaysia) by Bloomberg CCM Doupharma Ltd (Malaysia) by Bloomberg Average P/E Vietnam Imexpha rm 8.1 by Bloomberg Tra pha co by Bloomberg OPC 9.58 by Bloomberg DHG 9.9 by Bloomberg Average P/E 9.67 Weighting of two P/E sources Source 1. Average P/E in Indonesia and Malaysia 2. Average P/E in Vietnam P/E Weight 25% 75% Fiscal Year 2013 (All figures in VND) Projected tra ns a tion P/E Earning Per Share 7,312 Ta rget Pri ce (VND) 74,171 Vietnam CFA Institute Research Challenge Page 20

21 Perpetual Growth Rate (g) APPENDIX 10: Sensitivity Analysis Target price with DCF method All figures in VND Cost of Equity ( Re) 14.1% 14.6% 15.1% 15.6% 16.1% 16.6% 17.1% 6.5% 82,783 77,260 72,387 68,056 64,183 60,699 57, % 87,959 81,734 76,287 71,481 67,210 63,390 59, % 93,924 86,843 80,703 75,331 70,590 66,378 62, % 100,875 92,730 85,745 79,690 74,390 69,715 65, % 109,076 99,590 91,556 84,667 78,693 73,466 68, % 118, ,684 98,327 90,403 83,606 77,714 72, % 130, , ,316 97,086 89,268 82,564 76,751 Target price with PE method All figure in VND PE Target price Vietnam CFA Institute Research Challenge Page 21

22 APPENDIX 11: Pharmaceutical development progress Vietnam CFA Institute Research Challenge Page 22

23 APPENDIX 12: Health Care Spending in Percentage of GDP Source: Vietnam CFA Institute Research Challenge Page 23

24 APPENDIX 13: Vietnam Pharmaceutical expenditure per capital Source: Vietnam Ministry of Health Vietnam CFA Institute Research Challenge Page 24

25 APPENDIX 14: Vietnam Burden of Disease projection from 2005 to 2030 Source: BMI s estimate Vietnam CFA Institute Research Challenge Page 25

26 APPENDIX 15: Vietnam medicine revenue ($Mln) IBM forecast (USD currency) % total market 2010 % total market 2020 CARG Positive factors Negative factors Patented drugs Generic drugs OTC medicines Overall market 23.4% 17.8% 12.8% Gradual reduction of tariffs on pharmaceutical products Added foreign competitors force domestic companies to improve efficiency Specialty medicines will be the key growth factor. 49.4% 55.8% 15.1% The Health Ministry promotes the use of domestically-produced products and releases guidelines that all hospitals are asked to prescribe domestic pharmaceuticals. Low consumer purchasing power. 27.2% 26.4% 12.6% Tighten regulations: ban on the sales of prescription drugs without the consent of doctors. Consumption habit of Vietnamese: 45% likely to take an OTC drug for minor ailment as soon as symptoms are present. 100% 100% 13.8% Increased pharmaceutical consumption from such a low level (26USD per capita per year) Expanding population Higher level of health awareness Increased access to pharmaceuticals Counterfeit drugs Global economic slowdown in 2009 fueled the demand for cheaper drugs Commission put many patented products beyond the budgets of the majority population of VN. Widespread belief that generic drugs are inferior to patented products. Raising value of the prescription sector. Stricter dispensing control. The market are saturated with unlicensed import offerings. Lack of control and regulatory bias against foreign products. R&D of domestic companies still cannot be the spearhead factor for the industry. Source: BMI s estimate Vietnam CFA Institute Research Challenge Page 26

27 APPENDIX 16: Revenue breakdown by area Source: DHG s annual report 2011 Vietnam CFA Institute Research Challenge Page 27

28 APPENDIX 17: DHG s history Source: DHG s annual report 2011 Vietnam CFA Institute Research Challenge Page 28

29 APPENDIX 18: Distribution channel Source: DHG s annual report 2011 Vietnam CFA Institute Research Challenge Page 29

30 APPENDIX 19: DHG revenue breakdown DHG revenue breakdown DHG sales volume breakdown Source: DHG s annual reports Source: DHG s annual reports % revenue % sales volume High value group 60% 25% Low value group 40% 75% High value group: accounts for about 25% volume but contributes about 60% revenue and this group will still predominate DHG revenue in the future. This group includes antibiotics, antifungal, antiparasite products and other extremely high value products such as diabetic, cardiovascular, nervous system, hepatic, biliary products (the Others group). We consider a strong potential development for this group because antibiotics, antifungal, antiparasite group is the key revenue generating factor with more than 40% of the total revenue and HDG still focuses on this group with new competitive products. Moreover, the Others group has been increased dramatically in the recent years with a CAGR of 30% in This is due to the new products that are welcomed by the market and it will be the factor that pushes the company revenue in the upcoming years. Low value group: accounts for about 75% volume but contributes just about 40% revenue and it has a tendency to be smaller as some groups of products, such as Vitamin-mineral, are moving to the high value market. In general, this group still maintains a certain growth as the OTC market is quite sustainable and bad environment conditions lead to a greater probability of getting common illnesses. However, DHG also has its strategy to improve more valuable products, especially in the Vitamins-minerals group. This strategy is applied successfully as the sales volume decreased continuously while the revenue still maintain. The high value group will lead the company s future revenue as it has potential revenue increasing factors that are unique wellknown products and lower price in comparison with that of foreign companies. Vietnam CFA Institute Research Challenge Page 30

31 APPENDIX 20: DHG revenue breakdown Source: Team s estimate Vietnam CFA Institute Research Challenge Page 31

32 APPENDIX 21: Extended Dupont analysis In terms of ROE, DHG is still the leader, with a ROE of 31.0% (2011) versus the 9-company averages of 23%. This ratio remained over 30% with no debt as it has for the last 3 years. Tax burden. Net income/ebt ratio tends to decrease slightly in period This means the burden of tax has affected somewhat to ROE. But from 2013, when the new factory is in operation, the company will receive the incentive policy that cuts tax rate in 15 years. Interest burden. DHG is not subject to the interest burden. The company even earned interst from its cash surplus. However, this kind of income tended to decrease in Moreover, with the need of spending cash on distribution system and the new factory, this earnings would be down in 2012 and In long-term, the money invested in core business activities is expected to be more sustainable and make more profit EBIT margin. DHG s EBIT margin have been shrinking slightly in the past five years due to the impacts of government policy and VND devaluation. However, it is still the highest and the most attractive amongst 15 domestic companies in Vietnam. The decline in margins is concerning but we expect this trend has come to an end. DHG should be able to increase its margins from 2013 when the new factory is put into operation. Asset turnover. In 2011, both Asset turnover ratio and total asset are increased. This indicates the company has used its asset more efficiently. Financial leverage. DHG has chosen the safe way by financing its resources with the percentage of 70% is equity. Source: DHG s annual report and team s analysis Vietnam CFA Institute Research Challenge Page 32

33 Rare Possible Probable APPENDIX 22: Risk matrix To boost the revenue in the period of , DHG will increase credit sell and untie the collection period. So, it increase the credit risk of DHG. However, applying ERP will minimize this risk by tighter management the inventory at agencies. Just 0.09% of medicine on the market is counterfeit but more than 1% of them are unqualified.. Before the strong competition of foreign terms, the quality - scandal such as unqualified product may affect to the brand of DHG and decrease its revenue. However, the development in perfect management to satisfy the national pharmaceutical standard will help DHG reduce this risk. Imported more than 80% of raw material, DHG is in passive position against foreign suppliers. However, the careful choice and remaining the good relationship with suppliers will help DHG decrease the affect of supply chain risk by the intermediate. Moreover, the increase in product capacity since the complete of new factory will increase the lack of raw material. In the short term, if the demand of material increase more than 17% per year, DHG cannot find the supplier who can satisfy the demand at the reasonable cost. This means DHG will have to increase the COGS and decrease gross margin or increase the number of output slower and satisfy with the low growth rate of revenue. Both of them affect major to Income of DHG. However, until 2014 when the new factory complete, DHG has found the new supplier to increase the raw materials which help it decrease this risk. Stronger competition Increase raw material cost Devaluation of VND Credit risk Low GDP growth rate Change in consumption habit Management risk Delay operation of new factory Tighter regulation Supply chain risk Quality Scandal Shortage of material Decrease in demand Source: Author s estimation Minor Intermediate Major Vietnam CFA Institute Research Challenge Page 33

34 APPENDIX 23: SWOT analysis Source: Team s analysis STRENGTH -The historical brand and being one of leading position -Large scale and expanding capacity -National wide distribution network and suitable Marketing strategy -Strong financial advantage and more development in R&D activities -Professional dedicated management board and high quality labor. OPPORTUNITY -Government strategy to develop pharmaceutical industry and satisfy popular demand -Increase in Vietnam popular and living standard that increase spending for health care -Domestic pharmaceutical terms have right to distribute directly WEAKNESS -The shortage of supplies: 80% of raw material is imported -Most products are generic form. -Production capacity does not meet the demand -The slow disbursement may delay the plan operating the new factory. -The lack of effective R&D activities than the foreign terms may reduce profit margin. -Data processing system is simple THREAT -The increase in COGS due to rising trend of material international market and uncontrollable exchange rate fluctuation - The disloyal customers -Stronger competitive from new foreign access - Fierce struggle between domestic companies on selling price and distribution network -The stricter management in seling price and operating conditions Vietnam CFA Institute Research Challenge Page 34

35 APPENDIX 24: Porter s Five Forces analysis BARGAINING POWER OF SUPPLIERS -DHG is in passive position against foreign suppliers: 80% raw material is imported. -Rising trend of material price because of the lack of supplier increases COGS and decreases margin. -Owned material zone is insignificant. BARGAINING POWER OF CUSTOMERS -Disloyal customers: doctor, pharmacist, etc. easily change supplier if they earn the higher commission. -Changing consumer habit: prefer to functional products than medicine. COMPETITIVE RIVALRY -Strong competition in generic segment -Fierce struggle between domestic companies on selling price and distribution network such as Traphaco, Domesco, etc. -Aggressive competition from foreign brand such as Sanofi, Novartis, etc. -The existence uncontrolled of counterfeit THREAT OF NEW ENTRANTS -High gross margin attracts more entrants, specially the foreign terms. THREAT OF SUBSTITUTE -Medicine is essential product that cannot completely replace. -Import tax decrease because of Joining WTO committee. -New foreign entrants have famous brand and R&D advantage. -The appear diverse dietary supplements pharmaceutical industry. threat to Source: Team s analysis Vietnam CFA Institute Research Challenge Page 35