Kalbe Farma Strong Positioning For The Future
We initiate coverage on Kalbe Farma with a BUY and DCF-derived IDR1,600 TP (33x/27x FY16F/FY17F P/Es, 19% upside). Its pricing power and economies of scale have strategically positioned it in the high margin-high volume segment and it aims to double its exports to 10% by 2020. It is also focused on creating a value-add product portfolio and two new milk production facilities are set to start in 2016; therefore we estimate its sales may grow stronger in the coming years. Kalbe Farma is the largest pharmaceutical firm in South-East Asia with significant economies of scale; it is in a unique position of being able to tap into the ASEAN Economic Community (AEC).
Focused on creating a value-add product portfolio for its prescription pharmaceuticals division which, along with its pricing power and economies of scale, would enable the company to remain in the high margin-high volume quadrant where it is currently. Growing export sales at a CAGR of 27.7% over the last two years; it is also aiming to double its current export sales to 10% of total sales by 2020 from 5% currently.
New milk production facilities ready to commence operations
Two new production facilities in West Java are set to begin operations in 2016: i) a liquid milk production plant in Sukabumi, and ii) a powdered milk production facility in Cikampek.
Growing ready-to-drink (RTD) consumer health products
Kalbe Farma is maintaining its position as one of the leading over-the-counter (OTC) products and energy drink players. OTC offerings continue to offer stable growth while RTD products are growth drivers.
Initiating coverage on the stock with BUY and IDR1,600 TP (19% upside)
Our DCF-based TP is derived using a 13% WACC and 5% terminal growth (TG), which implies 33x/27x FY16F/FY17F P/Es respectively.
Key risk
As Kalbe Farma imports 95% of all its raw materials, the weak IDR and frail purchasing power can adversely affect its profitability.
Investment Thesis
Strategically positioned in the high margin-high volume quadrant due to its pricing power and economies of scale. Along with its disciplined inventory management and sizable USD cash reserves, the company has smoothly weathered the weakening IDR vis-à-vis the USD.
Growing export sales
Kalbe Farma’s export sales grew at a CAGR of 27.7% over the last two years and the company is aiming to double its current export sales to 10% of total sales by 2020. As the largest pharmaceutical firm in South-East Asia with significant economies of scale, Kalbe Farma is in a unique position of being able to tap into the ASEAN Economic Community (AEC) with its 600m people and estimated combined GDP of USD2.4trn.
Value-add product portfolio creation for its prescription pharmaceuticals division
Unlike local peer Kimia Farma, which is building raw materials manufacturing plants, Kalbe Farma is focused on creating a value-add products portfolio. We believe this strategy ought to enable the company to remain in the ideal high margin-high volume quadrant that it is currently operating in.
Kalbe Farma commenced its new oncology factory in Oct 2014 and is constructing a biosimilar plant with target completion in 2018. Furthermore, its Stem Cell and Cancer Institute (SCI), Regenerative and Cellular Therapy (ReGeniC) and Kalbe Genomics (KalGen) are also key factors in enabling the company to introduce higher margin healthcare solutions. These are slated for the more advanced higher healthcare markets.
New milk production facilities in West Java ready to commence operations in 2016
Kalbe Farma’s new liquid milk production facility in Sukabumi, West Java, is set to start operations in 2016. This would enable the company to expand its offerings in the fast-growing liquid RTD milk segment. At the same time, a new powdered milk production facility in Cikampek – also in West Java – was completed and this facility is also ready to commence operations in 2016.
Growing RTD consumer health products
Kalbe Farma intends to maintain its position as one of the leading OTC products and energy drink players. The company’s OTC offerings continue to provide stable growth while the RTD products are the growth drivers for its consumer health division.
Initiating coverage on Kalbe Farma with a BUY and IDR1,600 TP (19% upside)
Our DCF-based TP is derived using a WACC of 13% and TG of 5%. This implies 33x/27x FY16F/FY17F P/Es. We corroborate our analysis with a peers comparison (Figure 1); Kalbe Farma’s higher ROAE and net margins justify its premium valuations.
Strategically Positioned In The High Margin-High Volume Quadrant
Kalbe Farma’s pricing power and economies of scale positioned it in the ideal high margin-high volume strategy quadrant (ie “Zone D” in Figure 2 below) when compared to its domestic peers. Along with its disciplined inventory management and sizable USD cash reserves, it has smoothly countered the weakening of the IDR against the USD.
Well-maintained margins
Kalbe Farma has been able to maintain its consolidated gross margins (Figure 3) despite the weakening IDR trend against the USD since FY11 by being able to increase the ASP of its products. Moreover, its practice is to hold 3-4 months of inventory as well as USD40m-50m of forex reserves within its coffers to finance its various import needs.
Higher sales contributions from the consumer health and nutritionals divisions
Since FY13, both consumer health and nutritionals divisions have been gradually contributing more, in terms of sales percentage, to Kalbe Farma’s total sales (Figure 5, 6). At the same time, its prescription pharmaceuticals’ sales contributions have been stable at c.25% of the company’s total sales. With the commercial operations of two new milk production facilities beginning in 2016, we forecast for the nutritionals division to contribute more going forward.
Growing Export Sales
Kalbe Farma’s export sales grew at a CAGR of 27.7% over the last two years and the company is looking to double its current export sales of 5% to 10% of total sales by FY20. As the largest pharmaceutical firm in the South-East Asian region with significant economies of scale, Kalbe Farma is in a unique position of being able to tap into the AEC with its 600m population and estimated combined GDP of USD2.4trn.
For the past few years, Kalbe Farma has been exporting more of its consumer health and nutritional products and it aims to market nutritional products and OTC medicines in Singapore and Thailand while focusing on energy drinks like Extra Joss in Nigeria. Kalbe Farma also exports Extra Joss, Diabetasol diabetic milk and Hydro Coco coconut drink to the Philippines. It exports Hydro Coco, Extra Joss, and Mixagrip flu and cough medicines to Myanmar while exporting Woods’ cough syrup to Singapore and Malaysia.
Prescription Pharmaceutical Division, a Value-Add Portfolio Creation
Cancer drug production. Unlike its local peer – Kimia Farma, which is building raw materials manufacturing plants – Kalbe Farma is focused on creating a value-add products portfolio which would enable the company to remain in the ideal high margin-high volume quadrant (Figure 2).
Kalbe Farma commenced operations at its new oncology factory in Oct 2014, which now produces three oncology products, with five more in the pipeline.
Hence, the company is looking to gradually phase out its previous 19 cancer medication imports and nutritional supplements for cancer patients. These are for its customers in Indonesia and South-East Asia. Currently, cancer medicines contribute only a small portion of Kalbe Farma’s prescriptions division, but the company expects it to contribute significantly within the next five years, with annual average growth of 20-25%.
Biosimilar-based drug production preparations
Kalbe Farma is building a biosimilar plant in Cikarang, West Java, with target completion earmarked for 2018. The biosimilar plant is to produce erythropoietin, a hormone that can increase the production rate of red blood cells.
Building stem-cells and genomics expertise
Kalbe Farma’s SCI, ReGeniC and KalGen are key factors that enable the company to introduce higher-margin healthcare solutions to the more advanced healthcare markets. Specifically, Kalbe Farma has entered into a licensing agreement with Stemedica, a San Diego-based biopharmaceutical company that develops and manufactures adult stem cell products for use in clinical and pre-clinical trials. And via its ReGeniC brand and cooperation with key public hospitals, Kalbe Farma has started offering several stem cell regenerative therapies.
Maintaining market share
Kalbe Farma has been able to maintain its market share above 12% since FY11 (Figure 13). For licensed drugs, the company maintains and actively establishes licensing relationships with leading pharmaceutical companies, such as Baxter World Trade Corp (Baxter), Astellas Pharma (Astellas) (4503 JP, NR), Samyang Corp (Samyang) (145990 KS, NR), Daiichi Sankyo Co Ltd (Daiichi Sankyo) (4568 JP, NR), Sinclair IS Pharma (Sinclair) (SPH LN, NR), Orion Oyj (Orion) (ORNAV FH, NR), Smith & Nephew (SN LN, NR), BioGaia (BIOGB SS, NR), Boryung Pharmaceutical (Boryung) (003850 KS, NR), Cymbiotics, and Helsinn Healthcare (Helsinn).
Unbranded generics likely to keep on growing
As most of Kalbe Farma’s unbranded generics products are used by government hospitals for the country’s universal healthcare programme (JKN), the company expects this segment to continue growing forward.
Kalbe Farma is not likely to increase the ASP for its licensed drugs and branded generics this year due to the currently weak domestic purchasing power environment. If ASPs are risen, more switching to lower margin unbranded generic drugs are to be expected.
Continued commitment to research & development (R&D)
Kalbe Farma is actively involved in state-of-the-art research works in drug formulation and cancer drug development, as well as in stem cell, genomic testing and biotechnology. The annual R&D spending, as percentage of total sales, has been constant at c.1% of total sales.
Nutritionals: New Production Facilities Ready To Commence In 2016
The new liquid milk production facility in Sukabumi, West Java, is slated to start operations in 2016. This will enable Kalbe Farma to expand its offerings in the fast-growing liquid RTD milk segment. At the same time, the new powdered milk production facility in Cikampek – also in West Java – was completed and is also ready to commence operations next year.
Large growth potential as Indonesia’s milk consumption per capita is still low
The nutritionals division serves the growing middle class population that is increasingly becoming more health conscious. Furthermore, milk consumption per capita in Indonesia is well below the consumption of its ASEAN peers, implying that there is plenty of growth potential in this sector.
Leading milk products still gaining market share
Kalbe Farma’s leading milk products – eg Diabetasol, Milna, Morinaga, and Prenagen – continue to command significant market share in their respective segments. Meanwhile, the company’s new products for the mass market, eg Zee, continue to enjoy significant growth results in FY14.
Margins pressure from IDR depreciation
As previously shown in Figure 7, this year we expect Kalbe Farma’s nutritionals divisions’ gross margins to be under pressure because the IDR has depreciated c.10% YTD (as at October) despite the relatively flat price of skimmed milk during the same period. The company decided not to increase the ASP of its nutritional division’s products due to the currently weak domestic purchasing power environment.
Consumer Health: Growing RTD Products
Kalbe Farma maintains its position as a leading OTC and energy drink player. OTC products continue to offer stable growth and its RTD products are the growth driver for the consumer health division. This year, the company has been able to increase the ASP of its OTC products by about 3%.
Real transformation was initiated in FY12
In Jul 2012, it acquired a local beverage company, PT Hale International, well known for its Love Juice and Pomerama line of juice drinks. The acquisition resulted in an expansion of Kalbe Farma’s RTD product portfolio and provided access to ready-to-use Hale International’s production facility.
Distribution & Logistics Division
Kalbe Farma’s distribution business is run via its 91.75%-owned subsidiary, PT Enseval Putra Megatrading Tbk (Enseval) (EPMT IJ, NR). In addition to distribution, Enseval also manages Kalbe Farma’s raw materials trading and medical device businesses. We expect the growth of its medical device business to accelerate with the implementation of JKN in 2014.
The negative sales growth of its distribution division in FY14 and FY15F was due to the termination of distribution agreements with Abbott Indonesia, and its own strategy to put less emphasis on the low-margin tender business dealing with products manufactured by external principals.
Mitrasana clinics
The distribution division also runs Kalbe Farma’s retail health services, ie Mitrasana Clinics (100%-owned by Enseval) which provide a one-stop service with a 4-in-1 concept that includes a family doctor, pharmacy, laboratory and convenience store.
Disciplined Working Capital And Minimum Leverage
Disciplined inventory purchases
Kalbe Farma has been able to maintain its gross margins, despite the IDR weakening against the USD since FY11, since it holds 3-4 months of inventory on top of having USD40m-50m in its coffers to finance various import needs.
Minimum leverage
The company continues to rely on internal financing to fund operational and expansion needs, as reflected from its constant negative net gearing.
Valuation
We consider DCF as the most appropriate valuation methodology for Kalbe Farma due to its upcoming international expansion plan and as it operates in a defensive industry. As shown below, we assume a risk-free rate of 8.25%, a market risk premium of 5.0%, equity beta of 1.0, and a terminal growth rate of 5.0%, which results in a WACC of 13.0%.
We developed our DCF line-items from the assumptions for revenues shown for each of the four divisions (Figure 5), the gross margins by business divisions and overall margins.
Since FY13, both consumer health and nutritionals divisions have been gradually contributing more, in terms of sales percentage, to Kalbe Farma’s total sales (Figure 5, 6). At the same time, its prescription pharmaceuticals’ sales contributions have been stable at c.25% of the company’s total sales; with the commercial operations of two new milk production facilities beginning in 2016, we forecast for the nutritionals division to contribute more going forward.
One key growth driver for Kalbe Farma is its international expansion plan
The company has been growing its export sales at a CAGR of 27.7% over the last two years and is aiming to double its current export sales to 10% of total sales by FY20F from 5%. As such, we decided to conduct a scenario analysis on its export sales growth, as depicted below.
Key Risks
Foreign exchange risk
As Kalbe Farma imports 95% of its raw materials, a combination of weak IDR against the USD and weak purchasing power can adversely affect its profitability as it would not be able to increase the ASP of its products. However, it has been able to maintain its gross margin, despite the IDR weakening against the USD since FY11, due to its discipline of holding 3-4 months of inventory as well as keeping USD40m-50m reserved in its coffers to finance various import needs.
Drug deficiency
In Feb 2015, the company received complaints related to two products, ie Buvanest Spinal 0.5% Heavy 4ml and Tranexamic Acid Generic 500mb/Amp 5ml. Kalbe Farma responded by initiating a nationwide recall of these two products. The product recall was completed in 2Q15 as part of the company’s quality control measures and preventive responsibility to ensure that its consumers are maximally protected.
