Hyphens Pharma - RHB Invest 2019-07-03: Undervalued & Under-Covered; Initiate BUY

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HYPHENS PHARMA INTL LIMITED (SGX:1J5)

Hyphens Pharma - Undervalued & Under-Covered; Initiate BUY

• Initiating coverage with a BUY and DCF-backed SGD0.25 Target Price (9% WACC, 0% TG), 28% upside, implying 12.2x FY19F P/E) plus 2.8% yield.
• HYPHENS PHARMA INTERNATIONAL (SGX:1J5) is one of Singapore’s leading specialty pharmaceutical (pharma) and consumer healthcare groups with an ASEAN presence. It is trading at 9.6x FY19F P/E (industry average: 17.8x).
• We believe the specialty pharma principals and proprietary brands segments are equipped for growth in the near term. We forecast revenue and NPAT CAGRs of 7% and 19% for FY18-21.

Hyphens Pharma Company Background

• HYPHENS PHARMA (SGX:1J5) started off when Inomed – incorporated by the group’s chairman, executive director (ED) & CEO Mr Lim See Wah and non-ED Dr Tan Kia King – and Mr Lim acquired Pan-Malayan Pharmacy (Pan-Malayan). The latter, established in the 1940s, was involved in the wholesale supply of pharmaceutical products and medical supplies in Singapore.
• Hyphens Singapore, established in Jan 1986, was acquired by Inomed in Sep 2001 with an initial shareholding of 25%. At that time, the firm was involved in business development activities for pharmaceutical principals. Group ED Mr Tan Chwee Choon invested in Hyphens Singapore in Jan 2004 and, during this period, Inomed, Pan-Malayan, and Dr Tan collectively held the firm’s entire issued share capital.
• Following a restructuring exercise in Nov 2010, Pan-Malayan became a wholly-owned subsidiary of Hyphens Singapore, while Inomed and Dr Tan held 81.8% and 18.2% of the issued capital of Hyphens.
• In 2016, the group bought the entire issued share capital of Ocean Health Singapore, which owned the TDF and Ocean Health brands, as well as Ocean Health Malaysia.
• Hyphens Pharma currently comprises three main business entities:
  • Hyphens Singapore,
  • Pan-Malayan, and
  • Ocean Health Singapore.
• The group moved into an integrated facility – comprising an office, warehouse, and packaging space – in 2018, in view of unlocking synergies through the consolidation of its different business units.
• Hyphens Pharma’s core businesses comprise:
  1. Specialty pharma principals;
  2. Proprietary brands;
  3. Medical hypermart and digital platform.

Specialty pharma principals

• Hyphens Pharma signs exclusive distributorship, licensing, and supply agreements with brand principals to market and sell a range of specialty pharmaceutical products in relevant ASEAN markets. The principals are located mainly in the US and Europe. Three of the brand principals, whose products have contributed significantly to the group, are Guerbet, Biosensors Interventional Technologies (Biosensors) and Sofibel. Other principals include Bausch+Lomb and Chiesi Farmaceutici. As at 31 Dec 2017, Hyphens Pharma carries more than 30 products under its portfolio.
• The renewal of the exclusive distributorship with Biosensors – which was set to expire on 1 Apr – is currently undergoing, and the group does not foresee any issues with regards to this renewal. Hyphens Pharma’s others agreements are also expected to go through the normal renewal processes as they approach expiry. Revenue from this segment accounted for 57% of the group’s total topline in FY18.

Proprietary brands

• Under this segment, Hyphens Pharma develops, markets, and sells its own proprietary range of dermatological products and health supplements. The former is marketed under the Ceradan and TDF brands, while the latter are sold under the Ocean Health name.
• Dermocosmetic products are primarily sold through medical professionals, which include general practitioners, dermatologists, paediatricians, and pharmacists. Health supplements are marketed directly to the consumers in Singapore via retail channels. Aside from the island republic, this division’s products are also sold to customers in Vietnam, Malaysia, Indonesia, the Philippines, and other ASEAN states. Revenue from this business accounted for 11% of total revenue in FY18.

Medical hypermart and digital platform

• Hyphens Pharma is also engaged in the wholesaling of pharmaceuticals and medical supplies. Its customer base is made up of healthcare professionals, healthcare institutions, and retail pharmacies. It also operates an online platform, where the group allows registered customers to browse its wholesale product offerings.
• Revenue from this segment accounted for 32% of total revenue in FY18.

Business Analysis

• Hyphens Pharma derives its revenue primarily from the sales of goods under its three core business segments:
  • Specialty pharma principals;
  • Proprietary brands;
  • Medical hypermart and digital business.
• Sales of goods totalled 99.1% of its 2017 revenue. The other revenue came from tprovision of services such as advertisement fees, marketing services/activities, and commissions income from third-party logistics services.
• The acquisition of Ocean Health Singapore, as well as increases in sales volume of its Ceradan products, has led to an exponential growth in the proprietary brands segment (+SGD8.7m or 322.2% y-o-y) in FY16. In that same year, the group achieved higher sales volumes of its contrast media and coronary stent products due to deeper market penetration in Vietnam. Overall, total revenue increased SGD22.7m, or 29% y-o-y, to SGD101m during this period.
• In FY17, revenue grew 17% y-o-y to SGD113.2m on higher contributions from across all three business segments. Hyphens Pharma launched new products under its proprietary brands Ceradan and Ocean Health’s ranges, which contributed to the increase in sales volume. In addition, sales in Vietnam went up SGD8.4m (+21.8% y-o-y) as a result of higher sales volume of contrast media and coronary stents.
• The group’s revenue continued to grow at 7.3% to SGD120.9m in FY18 on strong performances from the specialty pharma principals and proprietary brands segments. Due to the high demand for specialty pharma products in Vietnam, the percentage of revenue generated from the ASEAN member state to Hyphens Pharma’s total revenue grew to 43.6% in FY18 from 37.4% in FY15. Consequently, this segment delivered a CAGR of 20% between FY15 and FY18, which represents c.57% of the group’s total revenue last year.
• The revenue generated from the speciality pharma products segment is highly concentrated among the three product groups, namely contrast media products, Biosensors’ coronary stents, and Stérimar nasal sprays, which contributed 14.6%, 11.3%, and 7.5% of FY17 revenue.
• The company’s GPM has ranged between 32-35% over FY15-18. The fluctuations between the margins were largely due to better margins from Ocean Health products, which were then offset by the declining margins from the specialty pharma principals, and hypermart and digital platform segments. As Hyphens Pharma has ownership of the products under the proprietary brands division, it has better control in setting prices, which can then lift up margins.
• In FY18, gross margins improved to 33.7% due to larger contributions from the specialty pharma principals and proprietary brands businesses, which command a higher margin. However, there was a slight dip in net margin to 4.5%, mainly due to one-off IPO expenses and impairment of goodwill related to the Ocean Health acquisition – this is in view of a slower growth rate against a weaker retail sales backdrop.
• As at 31 Dec 2018, Hyphens Pharma has a net cash of SGD19.4m. Cash & cash equivalents stood at SGD22.4m, with a short-term loan of SGD3m. Out of SGD22.4m in cash, SGD7m has been earmarked for business expansion.

Investment Merits

Undervalued counter trading at 9.6x FY19F P/E

• Undervalued counter trading at 9.6x FY19F P/E, which is at a steep discount to its peer average of 17.8x. Our DCF-derived Target Price of SGD0.25 implies 12.2x FY19F P/E, which is at a c.31% discount to the industry average. We think this is a fair valuation for Hyphens Pharma, given its scale vs peers.
• Hyphens Pharma's share price has declined by c.24% from its IPO offer price of SGD0.26 per share – it is also 28% down from its trading debut. We believe Hyphens Pharma’s valuation will catch up to be at least 12.2x, reaching our Target Price of SGD0.25.
• Nikko Asset Management, Qilin Asset Management, and Maxi-Harvest each entered into cornerstone subscription agreements at the IPO offer price, for an aggregate amount of approximately SGD7.9m during the IPO. Those investing into Hyphens Pharma now are getting this counter at c.25% lower than these initial IPO investors.

Growth opportunity in Vietnam for the specialty pharma principal segment.

• Sales in Vietnam grew to SGD52.7m in FY18, from SGD29.3m in FY15. This increase was mainly due to the higher sales volume in contrast media products, as well as coronary stents contributed by its Vietnam business unit. As the Vietnamese Government continues to increase its expenditure on upgrading healthcare facilities and services – especially in the provinces – we are likely to see continuous growth in this segment for Hyphens Pharma in the near term. As such, we estimate sales contribution from the ASEAN member state to grow by 5-8% over the next three years.
• Other growth drivers include partnering with new principals and bringing existing products into new markets. Hyphens Pharma group introduced three stock-keeping units (SKUs) in 2016, two SKUs in 2018, and one SKU in 2019.

Expanding and strengthening its proprietary brands product range: Ceradan, TDF, and Ocean Health.

• Hyphens Pharma launched six products in 2018 and has two products – Ceradan Advanced and TDF Fairence T-Complex – slated to launch in 2019. In FY18, the group successfully brought Ceradan into the Middle East and South Asia.
• This year, upon the launch of Ceradan Advanced, some of the existing Ceradan-brand products – that are currently being sold through hospitals and clinics – may be marketed through retail pharmacies, making them easier to reach end-consumers.
• We think the proprietary segment has huge growth potential, as Hyphens Pharma builds on expanding its product range and entry into new markets. It also includes brand acquisitions, such as Ocean Health in 2016. In fact, we have seen this segment’s topline grow to SGD13.2m in FY18, from SGD2.7m in FY15.

Asset-light model, high FCF yield.

• We like Hyphens Pharma’s low capex business model. Plants & equipment only make up 4.6% of total FY18 assets. With minimal capex required, FCF yield stood at c.6.6% in FY18. Excluding one-off capex on new premises, FCF yield should have been 11.8%. This allows Hyphens Pharma to sustain its dividend of SGD0.0055 per share in the coming FY, translating into a modest 2.8% yield.
• High FCF also helps the group to build its war chest for future acquisitions.

Financial Forecasts

Well-positioned for growth.

• We expect revenue to grow 3.5%, 6.1%, and 10.7% for FY19F-21F, driven by the growth of the specialty pharma principals and proprietary brands segments.

Expanding the specialty pharma principals portfolio.

• Specialty pharma principal – Hyphens Pharma’ mainstay – registered a 14.3% y-o-y growth in FY18. This growth momentum will likely sustain, in our view, as we estimate Vietnam sales to continue expanding by 5-8% pa. There are also other ongoing pipelines supporting growth in this segment, eg bringing an ear, nose & throat product into the Singapore market and introducing D-Cure into Malaysia. The group is targeting to open new customer accounts for existing products, as it furthers its reach to medical practitioners.
• As such, we forecast revenue in the specialty pharma principals segment to grow by 5-8% pa to reach SGD82.7m in FY21, as well as a reasonable 3% increase for the following two FYs.

New product launches for the proprietary brands segment.

• With the acquisition of the Ocean Health brand, revenue increased to SGD11.35m in FY16 and SGD13.17m in FY18 from SGD2.71m in FY15. We forecast this segment to have a slower growth rate of between 6-7% in FY19F-20F, as new key hires will take time to ramp up sales.
• We expect sales to reach SGD24.4m in FY21, marking an 86% increase from FY18’s revenue. Hyphens Pharma recently added the following key positions – business director for Hyphens Dermatology, business development director, vice-president for the Philippines, and associate marketing director.

Valuation

Initiating coverage with BUY and Target Price of SGD0.25

We initiate coverage on Hyphens Pharma with a DCF-derived Target Price of SGD0.25 and BUY call.

• Our Target Price implies 12.2x FY19F P/E. The stock is now trading at about 9.6x FY19F P/E, with a decent yield of 2.8%. Our DCF assumptions are:
  1. WACC of 9%;
  2. Terminal growth rate of 0%.

Industry Overview

Increasing healthcare expenditure by the Government.

• The public sector has seen healthcare expenditure grew by double-digits in the last couple of years up to 2015 (data shown on Data.gov.sg, the Government’s one-stop portal for publicly-available data sets). Expenditures reached SGD8.7bn (12.9% of total government spending) in 2015 from SGD2bn (6.74% of total government spending) in 2006. As the country’s population ages, demand for health and aged care services will continue to trend up – so will the Government’s healthcare expenditure. The estimated healthcare expenditure for FY19 is SGD11.72bn, up 10.3% y-o-y from a revised FY18 total expenditure of SGD10.63bn.

Vietnam recorded a GDP of USD223.86bn in 2017 – an all-time high – from a record low of USD6.29bn in 1989.

• According to the World Bank, the country is estimated to grow between 6.5% and 6.6% in 2009-2022.
• Demand for healthcare services in Vietnam is growing, not just in Hanoi and Ho Chi Minh City, but also in the country’s lower-tier cities. The Vietnamese Government is funding the facilities upgrades of its public provisional-level hospitals. The drivers behind the rapid growth in demand for healthcare products and services are:
  1. A changing demographic;
  2. A growing population;
  3. Robust economic growth;
  4. Rising income;
  5. Increasing health awareness;
  6. Better access to healthcare services.
• According to Business Monitor International, healthcare expenditure stood at 7.5% (an estimated USD16.1bn) of GDP in 2017. It is forecasted to increase at a CAGR of 12.5% to USD22.7bn in 2021. The market growth rate of the pharmaceutical products sector averaged 17-20% in 2010-2015, according to the General Statistics Office of Vietnam in 2017. This is one of the fastest-growing markets in the region, making it very attractive for foreign investments.

Introduction of a pharmacy law in Vietnam.

• This new law has come into force since 1 Jan 2017 and is expected to affect the domestic industry significantly. It is aimed at prioritising the purchase of locally-produced products. At present, the domestic industry mainly produces generic drugs, while foreign players dominate in the high-quality non-generic drugs segment. However, it must be stated that this law also favours foreign investment enterprises being established in the pharmaceutical sector – this is to provide better access to innovative drugs and advanced techniques.
• Overall, we think that there is rapid and sustainable growth in the demand for pharmaceutical products in Vietnam. On the supply front, whilst the Vietnam Government is actively pushing for the purchase of domestically-produced products, it may take some time before local players and manufacturers are able to produce high-quality drugs that meet international standards. Consequently, hospitals and clinics in Vietnam are more likely to procure overseas products from distributors like Hyphens Pharma to meet their needs.

Global atopic dermatitis treatment market size is growing.

• The prevalence rate of atopic dermatitis – commonly known as eczema – is increasing, with the urbanisation trend being one of the reasons behind this chronic disease. Coupled with rising treatment costs, the global treatment market size for this disease is set to increase to USD24bn in 2027 from USD5.8bn in 2016, according to a 2017 market report from Future Market Insights. In ASEAN, the market is estimated to grow to USD596m in 2027, from USD210m in 2016.

Peer Analysis

• We have broken down Hyphens Pharma’s competitors by three key segments, as the group faces different competitions from these various sectors:
  1. Specialty pharma principals. This industry is highly fragmented and Hyphens Pharma faces intense competition from large multi-national manufacturers and distributors, among others. The key competitors include DKSH and DCH Auriga, which both have an ASEAN presence. Other specialty pharma players in Asia include Katakura, Koa Shoji, and Charmacy. Domestically, Pharmaforte Singapore is also a competitor;
  2. Proprietary brands. Under the group’s proprietary brands, its main competitors for Ceradan products are brands like Cetaphil and Physiogel. As for Ocean Health, rival brands include Blackmores and Swisse. Hyphens Pharma’s TDF products compete with NeoStrata;
  3. Medical hypermart and digital business. The group’s key competitor in this area is Apex Pharma Marketing.
• The stock is currently trading at c.9.6x FY19F P/E. Our DCF-backed Target Price of SGD0.25 implies FY19F P/E of 12.2x, which is well below the peer average of 17.8x. At the current price level, Hyphens Pharma offers a decent yield of 2.8%, which is comparable to the industry average of 3.3%. See Hyphens Pharma's dividend history.

Key Risks

Unsuccessful outcomes or challenges faced in new/renewal of product registrations.

• Product registration/renewal must be granted by the relevant regulatory authority in its respective jurisdictions, before Hyphens Pharma can start marketing and selling them. The product registration process is an extensive and lengthy one, with uncertain outcomes. The group may face delays or unsuccessful registration due to reasons such as:
  • Incomplete product registration applications;
  • Failure to validate the safeness and effectiveness of a product to satisfactory levels set by the regulatory authorities.
• Furthermore, a regulatory authority may revoke licenses granted for products at any time. In the event Hyphens Pharma is unable to continue with the distribution of its products, or on-boarding new ones, its businesses and prospects may be adversely affected.

Reliance on relationships with brand principals.

• Under the specialty pharma business segment, the group procures products from its brand principals and sells them to the local and ASEAN markets. Most of these distributorship agreements are on fixed terms. Hyphens Pharma may lose the portion of sales generated from the distribution of products from a particular brand principal, should the principal decide not to renew its agreement with the group.
• In addition, Hyphens Pharma is also required to meet the terms laid out in the agreement, such as minimum order quantities. If the group fails to meet the terms stipulated in such agreements, it may face the risk of said principal terminating the agreement or appointing other agents – this should result in a loss of exclusivity to distribute.

High inherent risks

• due to the nature of the pharmaceutical industry. Hyphens Pharma, being the distributor – and also the principal for its proprietary brands – is exposed to risks inherent to the development, distribution, and selling of pharmaceutical products. The group may be subject to product liability, personal injury claims, wrongful death claims, or product recalls if products are found to be unsafe, defective, contaminated, or inaccurately labelled.
• Other risks include misrepresentation of the products by the distributors or sales representatives, which could lead to incorrect usage. If the abovementioned scenarios occur, it may cause material impact to Hyphens Pharma revenue and profitability. Its reputation will also be at risk.

FX fluctuation risks.

• The fluctuation in foreign currencies, particularly the EUR, USD, and VND, may impact Hyphens Pharma’s bottomline if it is not hedged effectively. The group sources its specialty pharmaceutical products from the US and Europe, and distributes it to the countries in ASEAN. Hyphens Pharma may incur FX losses if there are significant appreciations in the USD or EUR against the SGD or VND. Similarly, any significant depreciation in the VND, IDR, MYR or PHP against the SGD may incur losses to the group.
• Approximately half of Hyphens Pharma’s revenue (45-50%) and purchases (55-60%) are denominated in SGD. The rest are denominated in foreign currencies (20-25% in EUR, 15-20% in USD, and more than 10% in other currencies), with a similar proportion between revenue and purchases. Hence, the natural hedge helps to mitigate the risk of drastic fluctuations to a certain extent and, in cases where there are drastic fluctuations – eg the PHP – the group is able to adjust its prices.

Lee Cai Ling RHB Securities Research | Jarick Seet RHB Invest | https://www.rhbinvest.com.sg/ 2019-07-03

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