Equity Analysis /

Pakistan Pharmaceuticals: The price increase rally has more legs

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Intermarket Securities
    23 January 2019
    • Since the DRAP announced a 9-15% drug price increase on 11th Jan 2019, the Pharmaceutical sector has gained 6.5%. However, we believe that further share price gains are likely. This drug price increase is in addition to the annual CPI-linked pricing formula already in place, and significantly offsets the impact of a c. 25% weaker PKR on margins. 
    • This holds true even if companies choose not to fully avail the allowed price increase. Although overall sector volumes may stay intact (last 3yr CAGR: c 6.5%), fear of losing out to peers could lead to cautious pricing. Even so, gross margin estimates for our coverage companies rise by 1.0-2.5%. The impact on medium-term earnings estimates is an even higher 6-15%. Accordingly, we raise our TP for AGP to PKR113/sh (previously PKR98/sh) and for SEARL to PKR280/sh (previously PKR250/sh).  
    • The latest drug price increase underpins the upgrade in our stance on the Pharmaceutical sector to Overweight, from Marketweight previously. Our view is strengthened by expectations of modest PKR depreciation from here. The recent rally has more legs, in our view, where the sectors’ market capitalization is still c. 25% lower than its 52wk highs.  

    DRAP allows a drug price increase, over and above CPI: As per a notification issued on 11th Jan 2019, DRAP has announced a 9% increase in prices for hardship drugs and a 15% increase for all other drugs (scheduled and non-scheduled). This is in addition to the annual CPI-linked pricing formula already in place. The new prices will apply on fresh batches produced immediately after the sale of existing inventory, where pharmaceutical companies expect the positive impact on financials to reflect as early as 1QCY19. While lower than what was initially applied for by the pharmaceutical sector (30% increase), this is nevertheless a substantial price increase and significantly offsets the impact of c 25% devaluation of the PKR vs. the US$ since Dec’17. This is the second pricing revision this month, where the DRAP earlier increased market retail prices (some companies saw a price reduction) for over 800 SKUs of various drugs under hardship category. Although there has been pushback from opposition political parties, there has been no move to take back the price increases, and they appear likely to stay, in our view.  

    Competition may prevent companies from taking the full price benefit: In order to remain competitive, we think some companies may refrain from fully transmitting the 15% price hike, particularly in saturated segments such as respiratory and analgesics. Our talks with various managements suggest a minimum price hike of 7-8% is on the cards (some will take the full price increase of up to 15%). In general, we think pharmaceuticals will look to target volumetric growth at the cost of a bumper improvement in margins. This will allow them to gain greater market share in the longer run and maintain customer loyalty. Even so, there is a significant positive impact on margins - for our coverage, we estimate that gross margins will lift by 1.0-2.5% compared to previous estimates. Importantly, there is a recurring earnings impact, since the CPI-linked increases will now apply on a higher base price. Margins are unlikely to reach pre-PKR devaluation levels, in our view, but this is still a substantial and very welcome lift.   

    AGP is a major beneficiary: For AGP, we have conservatively assumed a 10% price increase for drugs (other than hardship). With GMs rising by c 2.5% on average over the medium-term, our earnings estimates across CY19f-CY23f rise by 12% on average. Consequently, our new Dec’19 TP for AGP rises to PKR113/sh (up 15% from PKR98/sh previously). For SEARL, the positive impact of the 9-15% price increase is partially diluted by the earlier decision on hardship cases. The company had some prominent brands in the hardship list (Gravinate, Hydrillin, Peditral etc.) and we understand some of these may have seen a downward price revision (management affirmation is awaited). As a result, the impact on GMs for SEARL is a muted c 1.0% vs. our previous estimates. Accordingly, our revised Jun’19 TP for SEARL also sees a more moderate 12% lift to PKR280/sh.  AGP trades at a 2019f P/E of 14.8x and P/S of 3.5x where we rate it a Buy. SEARL trades at a 2019f P/E of 18.1x and P/S of 2.6x where we retain our Neutral rating. 

    Risks: (i) Further regulatory tightening by DRAP, (ii) persistent depreciation of the rupee (iii) rising counterfeit and smuggled products and (iv) slowing exports.