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Story intact, but valuation is rich; Reap your gains

Downgrade to Neutral. ISP’s share price rally (+26% vs. -7% for EGX30 since our last update, on 2 April), backed by its solid growth outlook and products’ defensive nature, left valuation demanding relative to peers, even on a growth adjusted basis, with the stock trading on a 2019e P/E of 19.0x vs. peers’ 13.5x. That said, we cut our rating to Neutral from Overweight, while maintaining our forecasts and valuation at EGP13.2/share, on limited upside (c11%) and worry of an unforeseen negative outcome from ISP’s case ruling, scheduled for 16 July 2018.

Robust year ahead. We look for EPS growth of 80% this year, aided by: i) ISP’s market share gain (20% in 2018, +80 bps y-o-y), entailing better economies of scale, and ii) a new distribution contract, signed on Mar-18, with Novo Nordisk (60% insulin market share), adding EGP393mn in 2018e (c3% of revenue) and improving blended GPM (10% for Novo Nordisk deal vs. 8.6% for ISP in 2017). We are not concerned by ISP’s 1Q18 relatively subpar performance (EPS +46% y-o-y), as 1Q is the weakest on seasonality and the bulk of suppliers’ rebate, lifting margins, are booked in 2H.

Our base case assumes ISP will not be found guilty. The ruling in ISP’s case, related to alleged anti-competitive practices and breaches of relevant competition laws, is scheduled for 16 July 2018. Our valuation does not incorporate any potential charges on ISP. As per the law, the maximum penalty would be set at EGP500mn, which would knock EGP0.50/share off our TP to EGP12.7/share. Assuming a worst case scenario, that select executives from the company will be fined EGP500mn each, would result in a total fine of EGP2bn, bringing our TP to 11.1/share. In case of the latter, ISP will likely need to leverage up to pay the fine, and halt dividend distribution, hindering FCF generation, and lowering our 2018-20e EPS CAGE to 50% down from 54%. We see low risk on expansions given the limited capex needs. Please refer to our last update for more details on the case.  

Pharma re-pricing remains in the grey. Since the Ministry of Health (MoH)’s Jan-17 decision to raise select drug prices by 30-50%, no major adjustments were made to the market. The Chamber of Pharmaceutical Producers reportedly plans to submit a request, next week, to the MoH, to raise drug prices to counter mounting costs. Meanwhile, select newswires reported that the MoH denied any increase in prices in the near future. Although we believe it is inevitable, but given the lack of clarity on timing, our model does not account for a future price hike in pharma products.