AFT Pharmaceuticals — Re-acceleration leveraging its platform

AFT Pharmaceuticals is a New Zealand based specialty pharmaceuticals company selling over 130 proprietary and in-licensed products, covering a wide range of therapeutic categories primarily in the over the counter (OTC) markets (c 60% of sales). The remaining 40% is derived from prescription and hospital products. The company markets its products directly in its domestic markets (Australia and New Zealand) and through distribution/licensing agreements in other markets like Asia and the rest of the world. AFT lowers its overall risk by steering away from drug development of new chemical entities and instead focuses on improving existing treatments. The product portfolio is an equal mix of own-brand products, in-licensed products rebranded and sold by AFT and in-licensed products sold under partner brands. All products are manufactured through contract manufacturers across the globe, resulting in reduced overheads while offering a broader manufacturing scale and scope. Maxigesic (analgesic) is one of top-selling products for AFT (15–20% of total sales, to our knowledge) and the company is currently focusing on its global roll-out.

AFT reported revenue of NZ$130.3m in FY22 (the period ending 31 March 2022). This represented a solid 15.2% growth over FY21, primarily driven by double-digit growth across all regions despite COVID-19 headwinds and supply chain interruptions during the year. The growth was skewed towards H222 (NZ$74.8m in revenues versus NZ$55.5m in H122), benefiting from new product launches. Increased licensing revenues from international operations (aided by the one-time fee of NZ$4.8m from the licensing agreement with Hikma Pharmaceuticals in H122) was another factor supporting this re-acceleration. Domestic markets (Australia and New Zealand) accounted for 86% of the total group revenue, while the remaining 14% was contributed by other Asian markets and international business.

Despite inflationary pressures and increased input costs during the period, the FY22 gross profit margin improved by over four percentage points (to 47.4% from 43.1% in FY21 due to an improving product mix and the ability to pass through cost increases in OTC products, along with contribution from the Maxigesic IV licensing deal in the United States (which fell straight through to the bottom-line). The higher revenues allowed the company to scale overhead expenses in sales and marketing (S&M) and general and administrative (G&M), and as a result the operating margin expanded to 15.6%, up from 9.5% in the prior year. Net profit increased more than 154% to NZ$19.8m in FY22.

Revenue from Australia, which accounted for 59% of the FY22 revenue, was up 12.3% y-o-y to NZ$76.7m. The OTC channel, which represents approximately 62% of revenue for Australia, grew 10.9% mainly due to strong sales from Maxigesic (paracetamol/ibruprofen) and eyecare brands (primarily Hylo-forte, Hylo-fresh and NovaTears) along with new product launches including Ocuzo (a preservative-free treatment for eye infections), Allerclear (allergy product), the Hemptuary dermatology range, Opti-Soothe (a three-in-one dry eye treatment kit) and the Maxigesic hot-drink sachet line extension. The hospital channel, which represents 27% of sales in Australia, was up by 15.4% due to higher antibiotic sales with increasing footfall in hospitals and new product launches in H222. The prescription channel (11% of the country’s sales) increased 12.9% due to new product launches and some of the already marketed products reverting to normalised sales patterns. More importantly, operating margins in the region rose sharpy to 20% from 12% in the previous year (NZ$15.7m in operating profit in FY22 from Australia, from NZ$7.9m in FY21) and was the key contributor to the improvement in group operating margin during the year.

New Zealand revenue was up 15% to NZ$35.1m in FY22 despite difficult operating conditions as many pharmacies were locked down during the year, blocking independent customer access to AFT’s OTC products. The OTC channel (57.1% of New Zealand sales) grew 18.4% to NZ$20.1m, reflecting a trend towards normalisation in H222 amid eased COVID-19 restrictions, supported by new product launches including Opti-Soothe (eyecare pack), CrystaMed (first aid kit), Hemptuary line extensions and Ferro Lipo-Sachets. While the hospital channel (14.7% of sales) grew 6.3% to NZ$5.1m, the prescription channel (28.2% of sales) recorded 11% growth to NZ$9.8m as normalcy was gradually restored in hospitals and pharmacies in H222. Excluding head office costs, the region booked an operating profit of NZ$5.2m (up from NZ$4.0m in the prior-year period).

Asia revenue increased by 24.4% to NZ$5.5m in FY22, driven by the hospital and prescription channels, which grew 32% due to strong anti-bacterial sales. The OTC segment revenue remained largely flat over the year as sales growth in Malaysia was offset by lower sales in Singapore (due to pharmacies stocking up on Maxigesic in FY21). Operating profit declined to NZ$0.6m from NZ$1.4m in FY21, due to unfavourable product mix as hospitals stockpiled low-margin injectable antibiotics. For FY23, AFT plans to scale up operations to include more countries through licensing and distribution agreements.

Rest of world revenues grew by 32.2% to NZ$13.1m, largely resulting from licence payments from Hikma for Maxigesic IV (NZ$4.8m in H122). Royalties earned increased to NZ$0.5m from NZ$0.3m in FY22 while product sales declined due to continued COVID-19 headwinds and stockpiling in FY21. Operating profit was NZ$4.2m, up from NZ$1.4m in FY21, mainly reflecting the licensing payment. As a next step, the company has set up a subsidiary in Europe (AFT Pharmaceuticals Europe) to scale up operations further (including planned Maxigesic launches in different countries). For FY23, AFT has guided for operating profit to be in the range of NZ$27–32m.

Importantly, the company has followed through on its previously announced plans to initiate a dividend policy as a result of its improving operating performance. The board has announced its intention to pay dividends on an ongoing basis (a payout of 20–30% or normalised profit after tax), with the first dividend to be paid in relation to FY23 (we expect the initial interim dividend to be paid out in H223).

Maxigesic is AFT’s flagship IP commercialisation product line. It is a non-opioid family of pain relief medicines, a proprietary formulation combining acetaminophen with ibuprofen, two very popular non-opioid analgesics. Maxigesic uses a unique 3.3 to 1 acetaminophen to ibuprofen ratio formulation (500mg acetaminophen/150mg ibuprofen) for the purpose of pain relief. Maxigesic has demonstrated approximately 33% lower average pain scores over 48 hours after oral surgery in adults compared with an equivalent dosage of either acetaminophen or ibuprofen alone in a 135-patient randomised clinical trial.

Maxigesic’s commercial roll-out is being undertaken currently in three dose forms (tablets, the intravenous form and other oral dose forms like the oral liquid formulation). AFT intends to add a number of different formulations to its Maxigesic product line as a way of growing Maxigesic sales in both existing and new markets and as a means of lifecycle management. While the commercialisation process for current doses is in its initial stages, the company plans to expand to new dose forms in the near future. Maxigesic tablets (OTC product) are now sold and launched in 46 countries, up from 43 at the end of March 2021. Recent launches include Switzerland and Greece. The tablets are registered in 52 different countries and the company continues to seek licensing agreements and registration across Asian and South American markets.

Maxigesic IV (developed in collaboration with Hyloris Pharmaceuticals), which is a hospital-based product, is launched in seven countries (including Germany, Austria, South Korea and Panama) but registered in 37. The United States is an important target market for Maxigesic in all dose forms and, in a positive development, in April 2021 AFT out-licensed Maxigesic IV to Hikma Pharmaceuticals (a leading supplier of generic injectable medicines). The terms of the agreement include up to US$18.8m in upfront, regulatory and commercial milestones and a profit share (of which US$3.6m was received in H122 as an upfront payment). Note that while Maxigesic is yet to receive regulatory approval in the US, the PDUFA date has been set for 30 June 2022 and management plans to launch it by end CY22 on successful approval.

The following exhibit presents different dose forms/variants for Maxigesic and the respective patent expiry dates.

AFT’s key R&D pipeline projects include expansion of Maxigesic family of medicines, NasoSURF (a patented nasal drug nebuliser) and a number of trials for applications in dermatology, gastro-intestinal health and medicinal cannabidiol (CBD) products. During the year, the company added five more projects (listed in Exhibit 6 below), out of which three (HS, BT and SD) are late-stage projects. The company is still exploring additional projects to further strengthen its R&D pipeline. We note that AFT’s strategy is to develop its R&D programmes in partnerships (such as with Hyloris for Maxigesic IV and Timber Pharmaceuticals for Pascomer), mitigating some of the risks related to new product development. Following the recent FDA approval of Nobelpharma’s topical rapamycin formulation for facial angiofibromas (AFs), AFT’s Pascomer R&D programme is unlikely to pursue this indication in the United States (Nobelpharma received orphan-drug designation from the FDA, which would prevent Pascomer from competing during the associated seven-year exclusivity period) and will instead focus on other indications such port wine stains (PWSs). The first study in PWSs is likely to commence in Spain in the next couple of months.

We value AFT using a discounted cash flow (DCF) valuation methodology. We have incorporated the recent FY22 performance in our model and have made minor adjustments to our forecasts. While our revenue estimates have been upgraded to reflect strong domestic market traction (more details in the financials section below), we have pared down our operating margin estimates slightly to factor in the current run-rate, FY23 management guidance (NZ$27–32m in operating profit) and our updated assessment of group operations (a higher contribution from the domestic market but more protracted growth from the higher-margin international operations). Our implied enterprise value resets slightly lower but has been offset by a lower net debt position. Overall, our valuation is largely unchanged at NZ$680.8.m or NZ$6.50 per share (from NZ$671m or NZ$6.41 per share). We note that our valuation does not capture the company’s ongoing R&D programmes and as a result has not been affected by the aforementioned Pascomer event. Exhibit 7 shows the sensitivity of our valuation to terminal EBIT margin and revenue growth assumptions.

We have increased our revenue estimates for FY23 to NZ$156m from NZ$150m. The change in revenue forecasts was mainly driven by higher growth estimates for Australia based on management guidance for higher year-on-year growth for Australia in FY23. We have also increased our sales forecasts for New Zealand (albeit lower than Australia) due to the strong growth recorded in FY22 and visible signs of the market recovering from COVID-19. For Asia, on the other hand, we have trimmed our expectations down from our previously bullish estimates to factor in the current run-rate. On the costs side, we have increased our FY23 estimates for R&D expenditure from NZ$6.4m to NZ$6.6m to incorporate the impact from the expanding R&D pipeline.

The key modifications in our forecasts are related to operating profit margins, which we have now trimmed by two percentage points in FY23, primarily due to a change in the contribution mix of the different geographies in our forecasts. We now expect a higher contribution from the domestic Australia and New Zealand markets but a lower contribution from international sales (which, due to being made up largely of licensing income, have 100% margins).

The company reported NZ$7.9m in cash and NZ$37.2m in debt at the end of the year. As the company has met both its earnings guidance (operating profit between NZ$18m and NZ$23m) and net debt target of NZ$25–30m in FY22, AFT has announced its inaugural dividend policy; the board intends to pay regular dividends within the range of 20–30% of normalised net profit after tax, subject to factors such as earnings, financial condition and outlook for the industry, further capital and R&D requirements. The policy will be applicable from FY23, and we have incorporated this in our model.