Team 06 Student research This report is published for educational purposes only by students competing in the CFA Institute Research Challenge MARKET DATA (VND) Price (11/19/2012) 52-week high 52-week low YTD change YTD %change Shares outstanding (mn) Market capitalization (bn) 65,500 74,900 52,300 8,200 14.6% 5.4 4,281.5 CFA Institute Research Challenge Hosted by Local Challenge (Vietnam) PERFORMANCE Team06 HAU GIANG PHARMACEUTICAL JSC KEY FINANCIAL DATA (FY12E) Per share data Earnings per share Cash flow per share Financial position Debt/Equity Profitability ROE Price, Nov 19 2012 ROA Upside EBITDA margin Market data Forward P/E Forward EV/EBITDA VIETNAM MARKET LEADER IN PHARMACEUTICAL VND7,701 VND8,905 2.9% ADD Price target VND78,500 27.8% VND65,500 22.2%20% 23.1% 8.8x 5.7x DATE: NOV 23, 2012 PHARMACEUTICALS TICKER BLOOMBERG: DHG_VN HO CHI MINH STOCK EXCHANGE Highlights We initiate ADD rating for DHG for the end-of-year 2012 Based on DCF and multiples valuation Our target price is VND78,500 with an upside potential of 20 percent from current stock price Highest revenue gained among domestic competitors: Revenue increased by 22 percent in 2011, arrived at VND2,490bn For the year 2012-2013, revenue is estimated to grow at percent per annum During the high growth stage of 2014-2017, CAGR is 17.1 percent Prime position thanks to economies-of-scale and long experience: DHG accounts for 5.1 percent of the total market, 9.8 percent among domestic companies In addition, the company is on the top five leading pharmaceutical manufacturers Functional foods - long-term strategy of DHG: The two functional foods, Spivital and Naturenz, have the highest growth rates among 11 main brands (75 percent and 52 percent respectively) This business line is expected to expand further and become the strategic sector of the company Wide distribution network - key driver of success: DHG owns a valuable asset to help surpassing competitors Its branches are available all over the country, cover in 98 percent of state general hospitals Debt-free balance sheet: DHG reduces financial risks by holding a low equity multiplier with no long-term debt Debt ratio stayed at one percent mostly assisting for cash needed in operation cycle A strong cash fund also supports the company’s liabilities Increasing manufacturing capacity owing to new plant accomplishment: The construction of the new plant in Tan Phu Thanh industrial park will be finished in 2013 After then output will increase successively and is expected to double by the year of 2017 Main risks to our target price are failure to gain back market share due to the increase in the level of competition in current market and the excess of supply over demand Other risks come from not being able to meet the planned capacity, volatility in exchange rates, and a stronger than expected increase in materials In addition, 43.4 percent of DHG’s equity belongs to the government while individual shareholders account for only 2.2 percent Investors should be aware of certain risks such as low liquidity and small floating Forecast summary Table 1: Net sales Unit: VNDbn 2011 3Q2012 2012E 2013F 2,491 2,025 2,700 2,909 17.2% 8% 8% 485 671 20.8% %YoY EBITDA 517 %YoY Net income %YoY EPS (VND) %YoY 416 6,375 2014F 2015F 2016F 2017F 3,408 4,072 4,763 5,478 17% 20% 17% 15% 744 861 1,003 1,155 1,309 30% 11% 16% 17% 15% 13% 359 503 539 594 700 826 949 15.3% 21% 7% 10% 18% 18% 15% 5,494 7,701 8,238 9,086 10,713 12,635 14,521 15.3% 21% 7% 10% 18% 18% 15% Figure 1: Price system Source: Team’s estimateInvestment VND 89,500 Relative P/E VND 85,500 FCFE VND 78,500 Target price VND 63,500 EV/EBITDA Multiple Relative P/B summary We initiate coverage of DHG with an ADD rating and a target price of VND78,500, offering a 20 percentage-point upside from its current stock price DHG is currently the key player in Vietnam Pharmaceutical market with a CAGR of 18 percent during the last five years There was a decrease of five percentage points in gross profit margin from 2010 (50.1 percent) to 2011 (48.5 percent) due to the impact of material cost However, we forecast profit margin will rise again after 2013thanks to economies of scale of Tan Phu Thanh new plant and the efficient distribution network Demographic factors in Vietnam such as population, urbanization and awareness to improve living standard, etc have recently changed It spurs DHG’s expansion to meet the surging demand in the future Although pharmaceuticals are still dominant at 87.7 percent, functional food segment is expected to bring more and more profit and its proportion will go up to 16 percent in 2017 The new factory will start operating in Q2/2013 and reach full capacity in 2020 once the production will be double Sales are estimated to grow at the rate of 15 percent of CAGR over the next five years Consequently, CFO will also increase DHG is expected to obtain EBITDA CAGR of 14.3 percent and EPS CAGR of 13.5 percent during period of 2012-2017 Our target price of VND78,500 is based on the FCFE and multiple analysis Our FCFE model covers high growth stage and second stage value plus the terminal value of company After 2020, new company reach full capacity, terminal value is based on EV/EBITDA We use the average of current EV/EBITDA ratio of 14 peer companies, which have a similar market capitalization DHG forecasted EBITDA to derive enterprise value at the end of 2020 In our multiple analysis, the average multiple price is adopted to be DHG share price Weighs for FCFE and multiple analysis are 0.5 and 0.5 respectively We rate DHG stock Medium risk Main risks related to the fluctuation of material price and exchange rate as well as the price control of the government could affect directly to the DHG’s operating margin Figure 2: DHG noble titles Business description Forbes Asia 200 Best Under A Million 2011 First – class Labor Medal by State President DHG Pharma - For a more beautiful and healthier life! Second – class Independence Medal by State President DHG Pharma is one of the five leading manufacturers (by value) of Vietnam Special awards for Annual Report in three successive years pharmaceutical market.DHG has the highest revenue (VND2,490bn in 2011) Prestigious stock in Vietnam Stock Market in 2010 (04 successive years) among domestic competitors, accounting for 5.1 percent of the total Vietnamese “Vietnam high quality product” (16 successive years) pharmaceutical market and 9.8 percent among domestic companies The total revenue in the first three quarters of 2012 is VND2,025bn, or equivalent to 73.6 percent of this year target Its success relies on the expansive distribution network It is primarily engaged in producing generic drugs like antibiotics (contributing 43.1 percent to the company’s 2011 revenue), functional food such as vitamins and cosmetics The company was honored in Top 200 Performing Figure 3: Small and Medium Enterprises (SMEs) in the Asia-Pacific region by Forbes Magazine in 2011 Figure 4: Pharmerging markets definition GMP: Good manufacturing Practice GLP: Good Laboratory Practice GSP: Good Storage Practice Emerging markets targeted by pharmaceutical companies Pharmerging = [Pharm(aceutical) + (e)merging] (Source: Schott’s Vocab) Figure 5: CAGR of total health expenditure per capita 2000-2010 Pharmerging Countries Developed Countries Source: WHO Established in 1974, DHG was formerly a state-owned enterprise DHG Pharmaceutical Joint-stock Company was officially operated in 2004 with the initial charter capital of VND80bn Company held its Initial Public Offering (IPO) in December 2006 DHG has a modern and integrated factory system meeting WHO-GMP/GLP/GSP standards with the total production capacity of 4.1 billion units in 2011 The new factory under construction in Tan Phu Thanh Industrial Park will start operating in 2013 It is expected to double the company’s capacity in 2017, helping DHG meet the increasing domestic pharmaceutical demand DHG is also boosting production of functional food, which is planned to contribute 15 percent of total DHG's revenues in 2017 Industry overview and competitive positioning Solid foundation for further growth In 2011, the total value of Vietnam pharmaceutical market reached USD2.4bn, ranked as Third Tier: “Fast Followers”, which have good opportunities for growth According to IMS Health, CAGR of the Vietnam pharmaceutical industry will be 16.5 percent for the period of 2012-2015 and the market value is estimated to reach USD3.5bn in 2015 Strong boost from swelling demand Being essential goods, demand for pharmaceutical products is inelastic As a result, expenditure on healthcare is not affected much by the fluctuation of economic factors Furthermore, demand for pharmaceuticals is growing rapidly, fueled by demographic changes, expanding economies, and government initiatives In 2010, Vietnam total healthcare expenses per capita were USD83, four fold increasing compared to USD21 in 2000 As an emerging economy, Vietnamese people's healthcare expenditure is far behind the numbers of developed countries (Appendix 6) However, while growth in the major developed markets has continued to slow down from the beginning of this century, healthcare expenses per capita in Vietnam has been growing at an impressive rate of 15 percent per year in the same period This illustrates the promising prospect of Vietnam's pharmaceutical industry in the coming years Demand climb’s motivation in expanding production Figure 6: Main imported materials suppliers To meet increasing pharmaceutical need, the pharmaceutical industry has boosted total output with a jump by 24 percent from 2010 to 2011 Along with improving the total output, pharmaceutical companies have also diversified products porfolio In recent drugs registration phases, there are now over 2,000 new registered medicines, compared to just 700 in the year 2003 Due to a considerable amount of capital accumulated through soaring consuming output, domestic enterprises can concentrate on expanding investment to upgrade production capacity Heavy reliance on imported materials, mainly from China At present, 80 percent of materials are imported, dropped by ten percent in 2008 China is the largest producer (15 percent of global market share) of penicillin, cephalexin and its derivatives, which are Active Principle Ingredients (API) for antibiotics Antibiotics accounts for 60 percent of Vietnam pharmaceutical industry’s total revenue As a result, API’s prices in China have major influence on Vietnam’s price Until now, just few domestic manufacturers have been able to sign long–term contracts with their suppliers Moreover, materials account for over 50 percent of Inner: 2010 Outer: 2011 Source: Vietnam Customs Figure 7: Number of sales representatives cost of goods sold (COGS), so gross profit depends significantly on material’s price Complex and unstructured distribution network The success of distribution system network relies on personal relationships between medical sales representatives and doctors, hospital directors, pharmacist, etc All the domestic companies currently have developed a strong network of medical sales representatives Each of them plays an important role in approaching doctors, hospitals, pharmacies Sales representative is the key driver to make a strong distribution network Counting on well-known international brands and good product quality, multinational companies can compete equally to domestic ones Strategies of multinational and domestic companies in distribution (Appendix 7) Multinational companies rely on advantages of strong brand name and high–tech products that are not produced in Vietnam They Company of sales not have to spend muchNumber on commission cost for hospitals, doctors, and pharmacies As a result, the commission cost, mostly representative lobbying cost represents only five to six percent of their total revenue in Vietnam DHG 700 As all domestic pharmaceutical manufacturers produce similar kinds of medicines, they have to build strong relationship with DMC 350 interlocutors SanofiAventis to persuade hospitals 200 and doctors to prescribe their drugs Therefore, selling expenses can grow up to 30 percent of the total revenue Zuellig Pharma 120 Source: Company data Growing trend in M&A M&A has been blooming in Vietnamese pharmaceutical industry in recent years with many remarkable successful deals This proves that the industry in general is perceived to be currently performing well and has an inviting prospect Table 2: Vietnamese pharmaceutical M&A transaction Acquirer Acquiree Ownership before M&A After M&A CFR International SPA(Chile) Domesco (DMC) 42% 45.9% VND302,000m TRAPHACO (Vietnam) Dak Lak Pharma 0% 24.5% VND7,930mn Stada (Germany) Pymerphaco 23.7% 49% USD25mn Fortis HealthCare (India) Hoan My Medicine 0% 65% USD64mn Table 3: Target market share of domestic companies estimate Government regulation from legal instrument Price control policy There are many loopholes price control code and its practice, so drug prices are not well-regulated Since retail Present 2015 in the pharmaceutical 2020 prices are not allowed to exceed registered prices, some firms initially register at high prices to leave room for increases afterward VND15bn Average monthly sales >VND10bn Average monthly sales >VND7bn Average monthly sales >VND4bn Average monthly sales >VND2bn Average monthly sales [...]... solicitation of an offer to buy or sell any security This report should not be considered to be a recommendation by any individual affiliated with the Investment Research Challenge with regard to this company’s stock CFA Institute Research Challenge ... the rise Meanwhile, the company is constructing a new factory to raise its capacity If sales keep lagging behind production output, this can harm DHG’s expected sales and net income DHG should do market research carefully to avoid this problem Financial risks Source: Bloomberg & SBV Exchange rates volatility As 80 percent of DHG’s materials are imported, exchange rates volatility will have a great impact ... recommendation by any individual affiliated with the Investment Research Challenge with regard to this company’s stock CFA Institute Research Challenge ... manufacturers, DHG spends on imported materials instead of doing research and manufacturing active ingredients itself The pharmaceutical value chain Research Active ingredient Formularization R&D activities... problems (accounting for 30 percent of total revenue) Research and development: simple and unexploited Source: EU Economic and Commercial Counselors Research and Development activities of domestic