With this note we cut our target prices for Pharmstandard’s GDRs and local shares to $22.5 (from $25.0) and $71.9 (from $80), respectively. We maintain our BUY rating on both shares.
Results review: margins raise flags. FY11 revenue beat consensus and our expectations by 15% and 14%, respectively. However, the company’s top line growth of 44% YoY (to RUB42.7bn) in roubles was primarily attributable to third-party drug distribution (+120% YoY to RUB21.7bn) where margins are much lower vs Pharmstandard's OTC or prescription drug sales. Both of the latter units’ revenues were below our expectations in 4Q11 with OTC sales down 14% YoY in the period, mainly due to a 28% YoY dip in Arbidol sales. This implies that margin contraction was accelerating in 4Q11 and may continue well into 2012.
Pharmstandard’s 4Q11 growth rates were also impressive, beating our and consensus expectations. At the conference call held on Friday (10 Feb), the company guided for 30-31% EBITDA margin in 2011 and 16.5% gross margin in third-party drug distribution. This implies 70-75% gross margin generation in its organic sales in 2H11 which we believe is unrealistic given that Russian pharmaceutical market prices are strictly regulated. We therefore remain more conservative and expect 28% EBITDA margin in 2011.
We raise our revenue expectations for the company, yet we anticipate margins contraction driven by an increasing share of third-party product (TPP) sales in total sales. Localisation of TPP manufacturing should smooth the trend; however, growing competition, price regulation, sluggish growth in organic product sales and the maturity of Arbidol sales are likely to continue putting a strain on margins. As a result we cut our target price for Pharmstandard’s GDRs to $22.5 (from $25) and its local shares to $71.9 (from $80).
The stock still looks cheap vs peers… trading at a 46% discount to EM pharmaceutical producers’ 2012E EV/EBITDA, on our numbers. We view its 2012-13E PEG ratios, which are also lower than its EM peers, as generous.
…and regulation is the upside risk. The government prohibited drug price increases in late 2011 ahead of the elections, though consumers have begun trading up to more expensive drugs (the Russian commercial drugs and parapharmaceuticals market was up 15% YoY in value terms and down 0.7% in volumes in 2011 according to DSM). This suggests that there is scope to pass growing costs onto consumers which would boost the Russian pharma market in 2H12. For these reasons, we maintain our BUY rating on both share classes.
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