Equity 2 August 2013, 8:40am

Hungary Egis Q2 performance brings huge disappointment (3)

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The key second-quarter figures of Hungarian drugs producer Egis have greatly undershot the market’s call. This underperformance was the most dramatic on the net profit row.

Highlights of the earnings report:

- despite a slowly expanding Hungarian drug market domestic sales declined;
- this, however, was offset by a marginal growth in export sales therefore consolidated turnover stagnated;
- the CIS region showed a relatively strong performance once again, with Ukraine and other CIS markets in the lead;
- CEE sales fared poorly, as producers are faced with unfavourable regulatory environment on several markets here;
- export sales of low-profitability active pharmaceutical ingredients (APIs) grew more significantly;
- gross margin dropped slightly, whereas EBIT dipped by nearly 20% due to a strong base and a rise in operating expenses, coming in lower than even the most pessimistic forecast;
- financial results also delivered a blow to the company, as a result of which net profit plummeted by more than 40%, also undershooting even the lowest estimate;
- By end-June Egis has managed to reach 82% of the full-year EPS (earnings per share) consensus and 77% of the EBITDA consensus for 2013;
- cash and cash equivalents remain substantial, corresponding to 33% of the share price (per share).

In view of the Q2 numbers we would expect a negative share price reaction on the Budapest Stock Exchange (BSE) today, but we need to highlight that the share price dropped a lot over the past few days that could mitigate today’s price erosion, just like the still attractive valuation of the paper. The overall picture could, of course, be altered by management comments at a press conference to be held this morning. Egis Pharmaceuticals PLC’s financial year extends from October 1 to September 30. Accordingly, the period from 1 January 2013 to 31 March was the third quarter of the 2012/2013 business year. But for the sake of clarity and comparability we use calendar quarters in the following.

Egis published its Q2 earnings report on Thursday after market close. The table below contains the comparison of the actual figures and analysts’ estimates. This shows that on the main rows fared more poorly than expected. The biggest disappointment is the 15% lower operating profit and the fact that net profit came in 36% lower than projected. Both numbers were lower than even the most pessimistic forecast.

FX

Contrary to a year ago this time foreign exchange changes gave a boost to the revenues of Egis. The quarterly average EUR/HUF was practically flat compared to Q2 2012 (0.4% forint weakening), whereas against the RUB the HUF gained 3%.

In spite of all these the company’s consolidated profit stagnated in annual terms in the April-July period, as a decline in domestic sales was offset by a slight increase in exports. Q3 international sales came to 79% of the Egis Group’s turnover with a growth of 1% in euro terms compared to the preceding year’s third quarter.

Gross margin

Q3 gross profit totalled HUF 20.32 bn, a 1% drop over the base period. In the course of the quarter, the continuing price erosion in Hungary and Central Europe, as well as the impact of unfavourable exchange rates were partly counterbalanced by the change in sales mix.

“The gross margin in the reported period was aggregately improved by the change in sales structure and cost efficiency measures while worsened by less advantageous forex evolution compared to last year’s value and price erosions being especially intensive in Hungary," Egis said.

As a result gross margin declined, but it remains at a relatively high level in historical comparison.

Operating and net profits

Egis’s revenues and gross profit undershot the consensus of analysts moderately, whereas the company’s EBIT and net profit came in well below the market’s call. This could indicate that the analysts had expected a smaller rise in operating expenses than what Egis actually recorded.

General selling costs rose 11% yr/yr in Q2, primarily due to high marketing expenses of the products in the strategic markets of the Group, especially in the CIS markets where the commercial network was expanded.

R&D expenditure surprisingly dropped by 3% although this has not caused much of a change in the 12-month trailing data yet, the trend keeps pointing upward.

The balance of other operating expenses and income turned out worse than in the base period, which may be attributed to higher net payment by the company into the health budget. Egis made no further advance payment to Celltrion in the reported period. (In February 2010, Egis Pharmaceuticals PLC signed an agreement with Celltrion/South Korea for distribution of eight biosimilar products in the strategic markets of Egis Pharmaceuticals PLC. Under the general contract, also the product supply agreements for the first two products have been signed.)

As a result EBIT declined by 18%, but at this juncture we need to highlight that the base period was rather strong. Operating profit dropped both in quarterly and annual terms to 14.1% of sales revenue in Q2. Egis said its profitability continues to be ensured by the export activity.

The balance of financial activities further eroded the results and quite substantially too. Egis incurred a loss of HUF 1.5 bn on financial activities versus HUF -355 m posted a year earlier. The main factor in that was exchange rates; the HUF was at substantially stronger levels at the end of the quarter than a year earlier, which creates losses on the reassessment of receivables.

Consequently, Egis’ after-tax profit plummeted by more than 40%, which was a large enough drop to break the nice ascending trend of the 12-month trailing profit that has lasted for several quarters now.

Cash

Egis’s cash and cash equivalents have not changed compared to Q1, which is not bad at all considering the cc. HUF 2 bn paid as dividend in Q2. Net cash per share is around HUF 6,700 or 33% of Thursday’s closing price.

Regarding the company’s cash flow outlook we need to point out the acquisitions investors have been waiting for so eagerly that could be realised in the current financial year of the company, according to comments by Egis officials. From what we have learned so far the planned takeover is expected to absorb around EUR 100 million (HUF 30 bn).

Markets

At a 3% growth of the Hungarian pharmaceutical market domestic turnover of Egis fell 4% yr/yr in Q2, in parallel with which the company’s market share went down to 4.5% from 4.9%. Notwithstanding the forced price reductions of generic drug producers, Egis ranked the eighth largest supplier on the domestic drug market in the quarter. Among the generic medicine producers the Company kept its No. 3 ranking.

The fall in turnover is attributable to the continuous price erosion. According to IMS Health data, the Hungarian drug market experienced 3% increase in value terms through the April - June 2013 quarter in comparison with the year-earlier figure. Turnover of Egis was down 6% in forint terms principally as a consequence of prices moving down due to the blind bidding processes.

Within the framework of the price and reimbursement system effective since October 2011 (the so-called blind bidding system) further medicine price cut took place, at a more moderate rate than earlier, as from April 2013. Besides the blind bidding system, also the quarterly adjustment of reimbursement keys of medicines falling into the same INN category (so-called fixing) prevailed. In order to maintain the reimbursement and market position of its products, Egis followed the price trends on the market, and as from April 1, 2013 lowered prices again by 2.0% on average in Hungary.

Export revenues of the company rose 1% yr/yr in euro terms, with the CIS region remaining the engine of growth despite the fact that sales to Russia dropped 1%. We need to note, however, that the base period was rather strong there. EUR value of exports was tampered 2% by the euro exchange rate strengthening against several foreign currencies. Adverse forex impact affected primarily exports to the CIS markets (strengthening of euro was notable vs the rouble and the dollar).

Exports made 79% of the Group’s sales over the quarter. Sales in the CIS markets (including Russia) were realized at a value of EUR 44.7 million, showing a 2% increase on the strong comparative value (strengthening of euro caused 3% depreciation of the region’s turnover). Sales of Egis on the Eastern European markets came to EUR 31.3 million, 4% less yr/yr. In the rest of the world Q3 turnover exceeded the year-earlier figure by 8%.

Q3 sales in Ukraine totalled EUR 5.1 million with a 4% boost compared to Q2 2012 (5% higher in dollar terms). The base period was temporarily improved by pre-deliveries, explained by authority registration reasons, at a value of some EUR 0.5 million. Disregarding this impact, usual sales expanded 16%.

On other CIS markets, the Group generated total sales of EUR 8.9 million, up 9% yr/yr (12% more in dollar terms). Development was especially strong in Belarus. Over the quarter, Egis initiated the sale of its first biosimilar product on the Belorussian market.

In the third quarter, Egis generated turnover of EUR 31.3 million in the Eastern European countries, 4% less than a year earlier.

Q3 turnover in Poland, on the largest market of this region, came to EUR 13.6 m, a 4% drop compared with the last year’s figure (PLN 57.0 million, 6% down). Progress of the whole Polish drug market came to a standstill as a consequence of the negative impact induced by the introduction of a new price and reimbursement regulation last year.

In the Czech Republic, sales amounted to EUR 5.0 m, 7% below the strong comparative turnover (the drop in CZK was 5%). In Slovakia, Q3 turnover amounted to EUR 2.8 m, indicating a 10% decrease yr/yr. The level of turnover on this market, falling below the basis, was brought about by the rapidly declining drug prices. In Romania sales came to EUR 4.7 m, up 12% over Q2 2012 (11% growth in RON terms).

In the third quarter, the export of finished pharmaceuticals to the rest of the world came to EUR 5.0 m with a 1% decrease on the basis figure. The export of active substances and other products totalled EUR 11.2 m going up 12% yr/yr. The trend here was ascending over the past quarters, which is unfavourable especially in the latter product group, given that this is especially eroding margins.