Oct 3, 2020
Great results, but tough times ahead for Pharmaceutical giant
Officially a “Proudly Bidvest” company, the pharmaceutical giant provided pleasing results. But does Adcock have a rosy future?
Adcock Ingram holdings is a leading pharmaceutical manufacturer listed on the Johannesburg Stock Exchange (JSE) in South Africa.
From humble beginnings as a small pharmacy in Krugersdorp 130 years ago, today the second-largest pharmaceutical manufacturer in South Africa. Adcock serves South Africa, some markets in Africa and maintains operations (Mainly manufacturing) in India.
Adcock is the largest supplier to critical care units within South Africa, and its impressive production plants have a capacity to produce 3.5 billion units of tablets and capsules per annum. Adcock distributes to its large range of customers more than 1 million units per day through their distribution partner RTT logistics.
Regulation
The pharmaceutical industry is heavily regulated within South Africa (and globally). The mainboard is the South African Health Products Regulatory Authority (SAHPRA). And the main act that regulates the industry is the Medicines and Related Substances act of 1965. A boring piece of information maybe. But, I mention it as it does become relevant.
In 2004 SAHPRA introduced SEP or Single Exit Price. SEP regulates the price that a manufacturer is allowed to sell its products to its customers. SEP also introduced regulation prohibiting incentives or rebates to customers. Therefore, no matter how much a retailer purchases, they will not get a discount. The idea behind SEP is to regulate the prices in such a way that everybody, no matter where they purchase the products, will pay the same price.
Noble indeed.
The Minister of Health is the one that sets future price increases on pharmaceutical prices. There is a formula that he uses to determine the price increases, and generally, the price increases are in line with CPI of South Africa (Usually between 4 and 6% per annum).
The Industry
As could be seen from the graph below, although SEP and increases keep up with inflation, it has not kept up with the significant deterioration of the Rand. This poses a significant risk, as the majority of the raw materials are imported.
Being in manufacturing within South Africa, unions play a major role in your business. Wage negotiations always end in increases far above CPI, and if not adhered to could result in a violent outcome. This further increases the expenses, especially direct costs, while selling prices are regulated.
For consumers this is fantastic. But from a business and shareholder point of view, this is not a great picture.
The South African government also announced its intention of a National Health Insurance (NHI) that will be funded by the government and regulate the industry even further. The NHI could have an adverse effect on the entire healthcare industry if not implemented correctly. This poses a significant risk and question about the long-term viability of the healthcare industry.
Market Share
The overall market is worth R56.4 Billion, with the largest focus on the private market that is worth R45.2 Billion (and shrinking).
There are currently 722 manufacturers all fighting for a slice of the pie. The top 20 manufacturers make up 74.1% of the private market, while the top 10 make up 55% of the total private Market. Adcock accounts for 16.15% of the total Private market at R7.3 billion in turnover.
Issues experienced
The year was not without issues. Not even for an essential service like a pharmaceutical manufacturer. With one of the Adcock plants in India being closed during the lockdown (Bangalore). The result, a decrease in output.
Luckily, Adcock was able to manage the effects of COVID very well, and is essential was not required to close down. Overall COVID costs during the period were R31 million. Although not ideal, not to bad either.
A more serious issue experienced is the water quality and water supply challenges at Adcock’s High Volume oral liquids and oral powder facility in Clayville. Water is essential to the process, and experiencing both quality and further supply issues poses another significant risk for the future. Adcock did build a new Ophthalmic facility. However, SAHPRA still needs to provide accreditation for this facility first.
The Results
You cannot be blamed for thinking that all healthcare companies performed exceptionally during a global pandemic (where healthcare is essential). However, due to the reduced numbers of flu, the normal winter basket (that makes up 40% of the OTC division) was abnormally low.
Due to the overall weakness in the economy, an increase in unemployment, and the uncertainty of the global pandemic, Adcock decided to not declare a final dividend. Deciding to rather hold onto their cash reserves, which was R317 million at year-end.
No dividend is a decision taken by many businesses, to ensure long-term sustainability. Keeping in mind that the global pandemic did have an effect on multiple divisions within Adcock, their overall result remains pleasing.
Adcock’s turnover grew to R7.3billion, which is an increase of 3.8%. Unfortunately, gross profit decreased by 1.8% due to higher wages, additional COVID expenses, and a weakening rand. The trading profit was down 1.1% to R944 million from the prior years R955 million.
The Conclusion
Adcock Ingram performed very well in a very difficult economy. Operating in a struggling economy and a highly regulated environment, continuous cost management, and “right-sizing” of the business is what is going to keep them profitable and sustainable (to a point).
Investors have been negative towards the Adcock share price for some time, with a decline of 27.48% year to date.
Unfortunately, even with the addition of brands like Plush and further acquisitions in the pipeline, Adcock is a true SA Inc (South Africa focused) company. Shareholders have lost their appetite for SA Inc stocks, as the environment has become too volatile and unsustainable. The SA economy will take years, if not decades to truly recover.
Adcock has performed well. But if they will keep on performing in the long-term. Hopefully, the answer is yes. But my honest opinion is maybe not.
