March 18, 2019/CardinalStone Research
In this report, we provide an update on Fidson Healthcare Plc, following its ongoing capital raising exercise. We highlight that the net proceeds of the rights issue will be used to finance working capital needs, as well as deleverage the company’s balance sheet. We see this singular exercise as one that will result in earnings accretion, as c.43% of the company’s operating profit was used to service debt (based on 9M’18 numbers).
We believe scope to grow volumes still abounds
Fidson’s ultra-modern plant which has been adjudged one of the largest pharmaceutical manufacturing facilities in Africa has continued to deliver immense value to the company. According to management, the company has continued to ramp up on volumes, following the capacity expansion, with an average utilization rate at 75% and 71% in the infusion and pharma plants respectively over 9M’18 (vs. 70% in 2017). Also, the company’s penetration into the low end of the market has continued to support top line and is expected to contribute further over the years. A key product of the company its intravenous fluids, which has gained significant traction since the introduction in 2017, contributing 12.5% to revenue by 9M’18. Management expects this to increase to 15% contribution in 2019, which we believe is achievable given the local demand supply gap for intravenous fluids. Management guided that it intends to focus on further product development over the medium term and in 2019 alone, it plans to introduce about 20 SKUs of new products across the ethical and over-the-counter segments. The company grew its volumes both in the premium products and the lowend-market products, despite weak consumer wallets in 9M’18. We take this as a positive and expect further volumes growth over the medium to long-term. Overall, the company has grown its revenue at a CAGR of 14.4% over the past five years to N14.1 billion in FY’17.
Capital raise to address key pressure points
While we are sanguine on our volumes outlook, our major worries for the business are elevated input costs, as well as finance costs, which c.43% of operating profit was used to service the company’s debt over 9M’18. We believe it will be difficult to drive cost to sales ratio to historical levels of sub. 47%, given the significant devaluation of the Naira which has made imports more expensive. However, we opine that the pressure on direct input costs may be subdued if management proceeds with its plans to source key raw materials directly through strategic partnerships with foreign counterparts, as opposed to sourcing the products domestically from importers. That said, management has hinted that c.37% of the net proceeds (N1.1 billion) will be utilized to fund its working capital needs. As such, we see scope in cost-of-sales hovering at 51.0% in FY’19 (vs. 53.5% in 9M’18).
On finance costs, we highlighted in our note ‘’Riding on the wave of increased capacity” that a debt restructuring plan should bode well for the company, as high finance costs previously eroded potential earnings growth. We believe that the company’s move to deleverage its balance sheet is a step in the right direction, as we expect this singular exercise to result in earnings accretion for the company. For context, FIDSON will utilize N1.8 billion (c. 62.3% of net proceeds) to repay more expensive loans on its balance sheet. Going by provided breakdown, as at November 2018, the company had an outstanding debt balance amounting to N6.1 billion and the payment of 29.7% of its loan portfolio should bring effective debt-to-equity ratio to 36.8% in FY’19 (vs. 9M’18 72.9%)
Breakdown of interest-bearing loans as at 30 November 2018
Total outstanding debt balance stood at N6.1 billion, which included:
a) N496.3 million from bond issued at an interest rate of 15.5%
b) N2.4 billion of intervention funding obtained from the Bank of Industry and the Central Bank of Nigeria at interest rates between 7% and 12.5%
c) N428.4 million of finance leases obtained from commercial banks at interest rates between 23% and 25%
d) N917.5 million of import finance facilities obtained from commercial banks at interest rates between 21% and 26%
e) N578.2 million of overdraft facilities obtained from commercial banks at interest rates between 21% and 26%
- f) N1.3 billion of commercial papers at interest rates between 19% and 23%
Our take – an offering of value
Having highlighted the cardinal points of our investment case for FIDSON, we conclude that there is a substantial value proposition for investors, from a fundamental perspective. Our recommendation is largely hinged on the company’s ability to continue to grow its top line, given an ultra-modern facility, robust product offerings (over 250 drug products to its credit) and the demographic advantage the Nigerian market offers. We also note that the Federal Government has made locally manufactured products more attractive, given the 20% import duties on finished pharmaceutical products. On costs, post-rights, we expect the company to record significant savings in direct cost of sales, as well as finance costs. All in, we believe that the successful completion of the rights will result in earnings accretion for the company, thus returning value to its shareholders.