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Egypt small cap pharma | Initiate with Overweight ratings on Alexandria Pharma and Cairo Pharma

Cheap plays in a high growth market. Generics control c33% of Egypt’s pharma market, and due to the country’s low drug purchasing power (cUSD30 per capita in 2017), we expect this segment to outpace broader market growth (at a 2017-2021 CAGR of 23%, reaching 43% of the market by 2021). Expectations that the Ministry of Health will opt for gradual price deregulation also allow for superior growth. The MoH most recently approved price hikes in May 2016 (20% for all drugs priced less than EGP30/unit) and January 2017 (30%-50% on select SKUs). Other than EIPICO [Overweight | TP EGP153], we see value in Cairo Pharma (1.6% market share) and Alex Pharma (1.5% market share), as key beneficiaries of this backdrop, and the new Universal Healthcare Insurance Act (implementation due to begin in September 2018).

Undemanding valuation, despite recent rally. Despite that both Alex Pharma and Cairo Pharma trade on similar multiples (FY18e P/E of 6.3-6.7x, c63% and c41% discount to EM peers and EIPICO, respectively), offering a similar FY18e dividend yield of c7%, we prefer Alex Pharma on better visibility towards restructuring posed in its EGP105mn capex budget to develop its sterile area over FY19-FY20. Alex Pharma shows better liquidity, with the last 6M ADTV coming in 2x that of Cairo Pharma. However, a larger share of Cairo Pharma’s portfolio is made up of loss-making drugs (FY18/19 budget assumes EGP23mn in losses), which, if re-priced to breakeven levels (likely due to a low price base), would add 25% to our 12M TP vs. 6% for Alex Pharma. Meanwhile, our TP-implied multiples put Alex Pharma and Cairo Pharma on a FY17/18e P/E of 11.8x and 11.2x, respectively, at a discount of 35% to EM peers’ median of 17.8x, mainly to account for the strict regulation on pricing.

Cost inflation a risk we have considered. The cost breakdown for each Alex Pharma and Cairo Pharma is relatively uniform, with FCY-denominated raw materials forming 74-75% of cash costs, against exports of 7-8% of total revenue. We assume c8% p.a. inflation in raw materials for each player (in USD terms) vs. a top line FY18-FY23 price CAGR of 9% for both companies, with every additional 1% increase p.a. reducing our TP for Alex Pharma by 14%, and for Cairo Pharma by 23%, all else constant. In the event of sharp EGP devaluation, we expect the government will allow for pass-through to the end consumer, possibly with a delay. The second largest cost item for pharma producers is labour, forming 21-23% of costs, with our models assuming 12% increases p.a..