AFT Pharmaceuticals — H123 focused on portfolio expansion

AFT reported revenue of NZ$65.8m in H123, a solid 18.4% y-o-y growth over H122, primarily driven by strong organic growth across all regions and new product launches. However, benefits from the strong product sales across Australian, New Zealand and Asian markets were partially offset by lower licensing income, resulting from the delay in the anticipated licensing income from Hikma Pharmaceuticals (~US$6m). Domestic markets (Australia and New Zealand) accounted for 87% of total group revenue, while the remaining 13% was contributed by other Asian markets and international business.

H123 gross profit margin declined by over 4.5pp (to 43.6% from 48.1% in H122), attributed to the absence of licensing income, which comes with 100% margin. In addition, operating margins were affected by higher sales and marketing expenses (NZ$17.3m vs NZ$14.2m in H122) to support new product launches. Combined, these issues resulted in operating margin declining to 5.3% (down from 9.9% in H122).

Revenue from Australia, which accounted for 55% of H123 revenue, was up 23.5% y-o-y to NZ$36.1m. The OTC channel, which represents approximately 65% of revenue for Australia, grew 36.9% mainly due to sales normalising to pre COVID-19 levels as well as well as 11 new product launches. Maxigesic hot-drink sachets, in particular, performed strongly. The hospital and prescription channels, accounting for the remaining 35% of Australia revenue, recorded single-digit growth during the first half. With a further 15 products planned for launch in H223, management anticipates a comparatively stronger H222. Operating profit in the region declined to NZ$3.1m in H123 (NZ$3.6m in H122) due to higher selling and distribution expenses to support new product launches, however, operating margins rose to 14.6% in H123 from 12.4% in H122, benefiting from the company’s ability to pass on input price increases to end-customers.

New Zealand revenue was up 34.7% to NZ$21.3m in H123 due to strong growth across all distribution channels. The OTC channel (51.7% of New Zealand sales) grew 28.5% to NZ$11m, reflecting strong organic growth and improved traction from allergy and pain relief medicines. While the hospital channel grew 16.5%, the prescription channel grew 56.9%. Excluding head office costs, the region booked an operating profit of NZ$4.9m (up from NZ$2.0m in H122).

Asia (5.6% of H123 group revenue) increased by 26.1% to NZ$3.7m in H123, driven by 115% growth in the OTC business, supported by the distribution agreement with McPherson’s for the Singapore market and Maxigesic sales uptake in Malaysia and Hong Kong. As a reminder, AFT entered into a distribution agreement with McPherson’s in November 2021 to expand its OTC products reach to Singapore. The agreement was effective for a range of products including the tablet form of Maxigesic, premium Liposomal nutritional supplements and other pharmaceuticals. The hospital channel grew 44.1%. Operating profit slightly improved to NZ$0.5m in H123 (NZ$0.4m in H122).

Rest of world revenues declined by 37.8% y-o-y in H123 to NZ$4.7m, due to the lack of licensing income. While income from royalties increased slightly to NZ$0.3m (H122: NZ$0.2m), product sales materially improved by 71.6% y-o-y as Maxigesic’s sales reach expanded to additional countries (51 in H123 vs 46 in FY22). However, the organic growth was more than offset by lower licensing income, which also translated into an operating loss of NZ$0.3m (vs NZ$3.3m in H122) from the market. In terms of progress in the Maxigesic IV rollout in H123, the formulation has now been launched in Ireland, Germany, Indonesia and Panama, registered in Pakistan and licensed in a number of countries including Canada, Iraq, Kurdistan, Colombia, Peru and Chile. As a reminder, the US rollout has been delayed following the FDA’s request in July 2022 for additional information on the packaging of the product. The FDA feedback requires AFT, along with partner Hyloris Pharmaceuticals, to initiate additional studies, which are expected to commence before end-CY22 with targeted completion by CY23 (following which both partners will submit its response to the FDA). We therefore do not anticipate any further milestone payments from Hikma until FY25. Management has also communicated that the rollout of Maxigesic (in all forms) in FY24 would be slower than anticipated previously due to AFT’s withdrawal from Russia, regulatory delays in some regions (including the United States) and slow rollout in Africa. As a result, AFT has revised down its target countries to 73 (from 90) by FY24.

Given the H123 performance and near-term portfolio expansion plans, AFT has revised its FY23 operating profit guidance downwards to NZ$18–23m, from NZ$27–32m. Management has indicated its plans to invest an additional NZ$10m in sales and distribution activities in FY23.

We continue to value AFT using a discounted cash flow (DCF) valuation methodology. We have incorporated the recent H123 performance in our model and made some downward revisions to our forecasts based on the current trends and near-term visibility (more details in the financials section below). Our overall valuation falls to NZ$665m or NZ$6.34 per share, from NZ$680.8m or NZ$6.50 per share. Exhibit 2 captures the sensitivity of our valuation to terminal EBIT margin and revenue growth assumptions.

We have slightly decreased our revenue estimates for FY23–24 by NZ$3.7m and NZ$4.5m respectively, incorporating the delay in receiving the licensing milestone payment (estimated to be in the tune of US$6m) for Maxigesic IV from Hikma for the US market commercialisation (following the FDA’s decision to seek further information on the product’s packaging). The revenue decline has been offset in part by the better-than-expected performance from the domestic New Zealand markets as well as Asia and as such we have increased our revenue estimates for these geographies.

The major change to our forecasts is related to operating expenses, which were higher than anticipated in H123 due to increased sales and marketing expenses related to the 11 new product launches in the period. With further launches planned for H223 and FY24, we expect these expenses to remain above historical levels. In addition, the H123 operating margin was also affected by the lack of licensing-related income from international markets, which otherwise would drop down fully to the bottom line. Based on these trends, we trim our operating profit projections for FY23 (NZ$19.8m vs NZ$29.6 previously) and FY24 (NZ$33.5m vs NZ$46.0m previously) in line with the revised guidance.

Another change to our estimates is related to the dividend payout. We had previously anticipated AFT to pay an interim dividend in H223 followed by a final payment in FY24. However, we now assume the entire dividend payout to be made in one-go at the beginning of FY24.

The company reported NZ$8.8m in cash and NZ$38.2m in debt (excluding leases of NZ$3.1m) at end September 2022. We note that AFT holds an outstanding term loan from the Bank of New Zealand, of which NZ$30.2m is due for repayment in April 2023. However, AFT has communicated that it is in the process of renegotiating the term of the loan, which may result in an extension of the maturity date to April 2026. If this materialises, this should leave the company well capitalised to fund ongoing operations.