Karachi, October 10, 2022 (PPI-OT): Pharma: Economic woes weigh in on sector profits

We review Pharma sector’s financial performance during FY22 with a sample size of ten companies as a proxy to the listed sector.

Sector’s sales witnessed 15% YoY growth and stable margins, which was more than offset by higher finance costs and imposition of one-time super tax, leading to bottom-line contraction of 8% YoY. CPHL posted highest sales growth, while AGP maintained highest gross margin position at 55%.

Pharmaceutical sector underperformed the benchmark index by ~7% in FY22 (-18% performance), currently trading at attractive trailing P/E at 12.7x, vis-a-vis historical average P/E of 20x.

FY22: High inflation drives 15% YoY growth in net sales

We review Pharma sector’s financial performance during FY22 with a sample size of ten companies as a proxy to the listed sector. Net sales for FY22 clocked in at Rs191bn, up 15% YoY primarily driven by CPI linked price increases amid 8.9% inflation during FY21.

To recall, pharmaceutical product prices are regulated by Drug Regulatory Authority of Pakistan (DRAP) where manufacturers are allowed to increase prices of essential products by the lower of 70% of CPI or 7% whereas prices for non-essential drugs are increased by the lower of 100% of CPI or 10%.

CPHL posted highest growth during FY22, while AGP maintained highest gross margin position at 55%. Impact of higher inflation and PKR devaluation weighed in towards the end of the year during 4QFY22 where sector margins dipped 3%/4% QoQ/YoY.

Higher finance costs and taxes wipe off sales growth

Despite stable margins YoY at 34% for the sector, profitability faded as higher interest rates weighed in on finance costs reflected in the 65% YoY rise to Rs3bn. Imposition of super tax charged during 4QFY22, further dragged down profits as tax charges reflecting a rise of 47% YoY (4QFY22 Effective tax rate: 83%, FY22 effective tax rate: 37%). As a result, PAT for the year trimmed down by 8% YoY while 4QFY22 profits alone dropped 83% QoQ.

Sector trades at attractive multiples

With rising demand for healthcare in the country post COVID and growing bacterial infections and diseases post floods, demand for pharmaceutical drugs is expected to remain elevated during FY23. Moreover, with inflation expected to remain in double digits during the year, price hikes are expected to further fuel value growth in the sector.

Margins are expected to face pressure during FY23 as unprecedented levels of inflation and PKR devaluation translate into higher cost of production. As per industry sources, pharmaceutical manufacturers are pushing for a one-time price increase allowance by DRAP over and above the CPI linked increment to counter the impact of PKR devaluation. To highlight, there is historical precedent of such a price hike seen back in 2019.

Fears over macro headwinds kept the sector’s performance below KSE-100 index by ~7% in FY22 (-18% performance) with the sector currently trading at an attractive trailing P/S and P/E of 1.2x and 12.7x, respectively. We believe this depicts that market participants are discounting sector’s potential growth implied by its historical P/E of over ~20x.