This article first appeared in The Edge Financial Daily on July 17, 2017 - July 23, 2017

YSP Southeast Asia Holding Bhd
(July 14, RM2.89)
Initiate add with a target price (TP) of RM3.50: YSP Southeast Asia Holding Bhd (YSP SAH) ranks among the top FBM KLCI-listed drug makers in Malaysia by market capitalisation.

Its key customers are private general practitioners (GPs) and hospitals, which contributed about 50% of the total of financial year 2016 (FY16) sales. The group also has a diversified product portfolio, including veterinary drugs.

Besides benefiting from rising local private healthcare spending, expansion into more underpenetrated and emerging markets is also a key earnings driver.

The stock trades at 12.7 times calendar year 2018 (CY18) price-earnings ratio (PER). This is at a 28% discount to CIMB’s pharmaceutical sector’s historical five-year mean PER of 17.7 times.

We initiate coverage of YSP SAH with an “add” call and sum-of-parts (SOP)-based TP of RM3.50.

A generic drug maker and among the top five drug manufacturers in Malaysia, YSP SAH is primarily a maker of generic medicines.

We estimate that it is the country’s fourth-largest listed drug producer by market capitalisation. YSP SAH has an extensive range of largely own-brand products that includes generic medical drugs, over-the-counter (OTC) items, aquatic and veterinary drugs.

It also has a trading arm that retails various low-volume products, such as traditional Chinese medicine (TCM). YSP SAH has three production facilities, one each in Malaysia, Indonesia and Vietnam.

Currently, generics comprise 60% of total drugs sold in Malaysia (versus >75% of drug sales in the US and UK), of which 30% are produced locally and 70% imported. We believe sales of generics will continue rising in tandem with more product offerings, as users switch to generics for cost reasons.

This will also be spurred by the private healthcare spending that is growing at a faster rate than government healthcare spending. YSP SAH is set to benefit from this trend as sales to private GPs/hospitals made up 50% of its FY16 sales.

The company expects rising contributions from exports to be its key earnings driver moving forward.

Its key growth markets are in Asean, mainly countries with large populations and low penetration rates.

YSP SAH aims to continue registering more products in each market and increase competitiveness via a wider range of product offerings. Margins should improve from better economies of scale as production increases.

Undemanding valuations, despite a three-year earnings per share compound annual growth rate (EPS CAGR) of 16.9%, YSP SAH trades at 12.7 times CY18F PER, a 28% discount to CIMB’s healthcare sector target for CY18F PER of 18.4 times, despite consistently posting superior margins (gross to pre-tax level) versus most of its pharmaceutical peers.

We attribute YSP SAH’s better numbers to higher cost efficiency and a more profitable product mix (OTC, TCM and veterinary drugs).

We project YSP SAH’s three-year EPS CAGR (FY16-19F) at 16.9%, driven by: i) rising export sales, ii) higher demand for generics in the local market, and iii) a turnaround in Vietnam operations.

In our SOP, the pharmaceutical business is valued at 14.2 times CY18F PER (at a 20% discount to CIMB’s pharmaceutical sector’s historical five-year mean of 17.7 times), to which we add a net cash of 48 sen per share.

We advocate that investors accumulate this stock, given its strong earnings prospects and undemanding valuations.

Downside risks to our view include a sharp decline in sales volume and longer-than-expected product registration in export markets. — CIMB Research, July 13