AFT Pharmaceuticals — Global growth despite tough macro environment

AFT reported solid 27.2% y-o-y total revenue growth to NZ$83.6m in H124 (ending 30 September), driven by strong product sales across Asia and international markets (combined growth of 117%; 94% ex-licence income) and steady performance from the domestic markets (14% y-o-y growth). Globally, product sales and royalties increased by a material 24.3% y-o-y to NZ$81.7m. Licensing income was also up significantly to c NZ$2m (from c NZ$0.1m in H123) and primarily related to a sales milestone payment from AFT’s licensee in Italy. Domestic markets (Australia and New Zealand (ANZ)) continue to remain the company’s largest, although their share declined to 78.2% of total group revenue versus 88.2% in FY23.

Gross margins from product sales and royalties were down by 2pp to 41.6% due to a change in sales mix (lower post-pandemic demand for the high-margin cold and flu medication and vitamins and a higher contribution from the lower-margin hospital segment). However, the NZ$2m milestone payment meant that overall gross margins were down only slightly to 43.0% from 43.6% in H123. Reported operating profit declined by 6.0% y-o-y to NZ$3.3m, representing a margin of 3.9%, lower than 5.3% in H123. This was primarily due to increased investment in new products, R&D and marketing of new products in the ANZ market, which together offset the benefit from the higher revenue. R&D expenses increased significantly (up 26.0% y-o-y to NZ$3.5m, NZ$7m if we include capitalised R&D) as the company continued to invest in expanding its R&D pipeline (such as developing a topical treatment for strawberry birthmarks). Selling and distribution expenses were also up significantly (+37.5% y-o-y to NZ$23.8m) due to aggressive launch and marketing-related activities in the first half. Management has highlighted that investment in product marketing was weighted to H1 and is likely to unwind in the next six-month period (H224).

Net profit for H124 was NZ$1.8m, higher than the prior year’s NZ$1.5m due to lower net financial expenses and tax payouts. Furthermore, period-end net debt stood at NZ$30.6m, similar to the March 2023 figure of NZ$29.9m, with investments in growth funded through internally generated cash flows.

Revenue from Australia, which accounted for 51.1% of H124 group revenue, grew 18.4% y-o-y to NZ$42.7m, led by a mix of organic and new product growth. The OTC channel, representing 68.4% of segmental revenue, grew the strongest at 24.0% y-o-y, driven by strong demand across all seven core therapeutic categories (eyecare, pain management, dermatology, gastrointestinal, vitamins, allergy and hospitals). This was despite a reduction in demand for its cold and flu medicines and supplements (such as liposomal vitamins) following fading concerns around the COVID-19 pandemic. The other two channels – hospital and prescription – recorded high single-digit growth of 9% y-o-y each in H124. Operating profit for the region fell to NZ$0.5m (versus NZ$3.1m in H123), with operating margin declining to 1.3% from 8.6% in H123. This was primarily due to increased marketing spend associated with new product launches, estimated to reduce in intensity in H2, as highlighted above.

In the home market of New Zealand, revenue growth was flatter (up 6.5% y-o-y to NZ$22.7m) and primarily organic, unlike Australia. The hospital channel, which accounts for 15.8% of the segment’s sales, grew the strongest by 15% to NZ$3.6m. Revenue from the OTC and prescription channels was up by 6.8% and 2.1%, respectively. Operating profit, excluding group head office costs, was down to NZ$2.6m from NZ$4.9m in H123. Similar to Australia, this reflects the increased marketing spend on product launches combined with a higher contribution from the lower-margin hospital business in the sales mix. Including head office-related expenses, the segment reported an operating loss of NZ$2m, in comparison to operating profit of NZ$0.1m in H123.

We highlight that AFT launched 22 new products in domestic markets in FY23, which expanded the total number of product offerings in these markets to more than 150. With the H124 release, the company has increased the number of new launches planned in Australasia through FY26 to 73 from 68 earlier. This includes 20 in FY24 (26 previously) and 53 in FY25–26. Management has attributed the decline in number of planned launches in FY24 to some delays in receiving regulatory approvals. We understand that the bulk of the planned launches for this year will take place in H2, with related promotional activities anticipated in H125.

Unlike previous periods, the H124 uptick was driven by AFT’s overseas market growth, which benefited from the waning pandemic-related headwinds. Revenue from Asia (6.5% of H124 group revenue) rose 47.8% y-o-y to NZ$5.4m, with solid growth across all channels. The hospital channel, representing 73.5% of segmental revenue, grew 36.0% y-o-y driven by stronger than expected demand for Maxigesic IV in the Korean market, where it received regulatory approval in September 2021. The OTC channel (18.5% of segmental sales) also reported an impressive 88.2% growth supported by growing traction from the company’s e-commerce initiatives (primarily in China), although we note that this growth comes from a lower base. While AFT’s e-commerce presence in China has helped generate sales growth through the OTC channel, the recent approval of its Crystaderm antiseptic cream by the National Medical Products Administration should allow the company access to the offline retail and hospitals segments, which account for 75% of the OTC market in China, and is therefore a much larger opportunity. Operating profit in Asia improved substantially to NZ$1.6m in H124 from NZ$0.5m in H123, with the operating margin rising by 15.4pp to 29.9%.

The international segment was the best performing during this period, with revenues increasing by a solid 171.4% y-o-y in H124 to NZ$12.8m, helped by growing momentum in Maxigesic sales (now available in 66 countries vs 61 in FY23, in various formats) and NZ$2.0m in licensing income. Product sales and royalties rose materially by 132.0% y-o-y and licensing income was up significantly to c NZ$2m (from c NZ$0.1m in H123), mostly related to a milestone payment from its licensee in Italy. Management has highlighted Germany and Italy as the two countries where Maxigesic has seen the most traction. The strong top-line performance and benefit from the licensing income flowed down, with the segment reporting operating profit of NZ$3.1m (vs an operating loss of NZ$0.3m in H123). With several launches of Maxigesic planned in the coming months, including in the US (IV and Rapid), South Africa and Belgium (IV and tablets), we expect momentum to stay strong for this market. We also note that AFT formed a UK subsidiary in FY23 (AFT Pharmaceuticals UK, which is 70% owned by AFT with the remainder owned by its long-term collaboration partner, Edge Pharmaceuticals) and expects to generate first sales in FY24, including Combogesic IV (Maxigesic IV’s brand name in the UK) and another two hospital-based IV products. Our estimates do not currently reflect the UK opportunity, which therefore offers further upside to our valuation.

Management expects sales growth momentum to continue in H224 driven by the ongoing roll-out of Maxigesic (across several dose formats), gaining traction in Asia and international markets, and the launch of new products in Australasia. It continues to target rolling 12-month revenue of NZ$200m and FY24 operating profit in the range of NZ$22–24m (excluding licensing income expected to be received following the US launch of Maxigesic IV).

We maintain that the success of AFT’s overseas expansion plans rest on its ability to increase the geographic footprint of its flagship Maxigesic range of products (which we estimate accounts for upwards of 80% of the current international sales volume). Management has indicated that in the longer term the company aims to generate 35% of group revenues from international markets (from 8% in FY23). In this context, we see the upcoming launch of Maxigesic Rapid and, more particularly, Maxigesic IV, as key catalysts and potential inflection points for AFT. Note that these launches will mark the first entry for AFT into the US, the largest analgesics market globally, estimated at US$6.8bn and forecast to grow at a CAGR of 4.9% during 2023–28.

Maxigesic IV (to be marketed as Combogesic IV in the US) is essentially a double-strength formulation of the oral version (1,000mg paracetamol and 300mg ibuprofen) and has been licensed in more than 100 countries, approved in 46 and currently launched in 25 countries (including the key markets of Germany, France and Italy). Unlike the tablet version, the IV formulation specifically targets hospitals for the treatment of patients with post-operative pain, an area dominated by opioids. According to Persistence Market Research, opioids constitute more than 60% of the post-operative pain relief market, valued in excess of US$35bn. Although effective in managing pain, opioids tend to be highly addictive and, in light of the US opioid abuse epidemic, physicians have been challenged by a lack of effective alternatives in addressing patients’ post-operative pain. We believe that Maxigesic IV, as a non-steroidal anti-inflammatory drug, can provide a much-needed alternative. Recent uptake trends in European countries and South Korea provide early indications of the drug’s efficacy and bode well for a strong US uptake post launch. Maxigesic IV has been approved in the US for mild to moderate pain and for the management of moderate to severe pain as an adjunct to opioids. The approval was based on positive data from a Phase III study, which demonstrated that Maxigesic IV was well tolerated and offered faster onset of action and higher pain relief than paracetamol IV (the leading non-opioid analgesic) and ibuprofen IV alone.

AFT already has a commercial partner in place in the US (Hikma) and the product launch should trigger a milestone payment of US$6m (to be split 65:35 with partner Hyloris). Management expects the launch to take place in February or March 2024 and we estimate that the milestone payment will be received in early FY25. For Maxigesic Rapid, AFT continues to explore optimal distribution strategies for the US market.

AFT continues to invest in its R&D pipeline (total R&D-related expenses were NZ$7m in H124, up from NZ$6.3m in H123) and we see these new additions as instrumental in driving further growth for the company. As of 31 March 2023, AFT had 21 products in its development portfolio across different therapeutic areas such as pain management, eyecare, dermatology and gastroenterology. The most recent additions to the R&D pipeline include a topical treatment for strawberry birthmarks (dermatology) and an eye drop to target drug-resistant infections (eyecare), both of which will hold significant global sales potential if successfully developed. The company is also considering investing in another two projects to expand its pipeline.

Late-stage assets in the company’s R&D pipeline include the Maxigesic range of products (IV USA, Dry Stick, Day/Night and Cold, Flu & Sinus Kit), the ‘SD’ project in dermatology and the ‘BT’ project in gastroenterology (with a potential market size of c US$200m each) and three ‘KW’ projects (potential market size of c US$700m). AFT is also working on completing additional development work on its NasoSURF nasal nebuliser project, which faced some manufacturing glitches during FY23. Furthermore, it plans to commence studies to demonstrate the safety and efficacy of Maxigesic in children (clinical studies expected to continue through 2026) which, in our opinion, will broaden the addressable market for Maxigesic products. Exhibit 2 presents a snapshot of AFT’s selected R&D projects.

We have made adjustments to our explicit FY24 and FY25 estimates (both revenue and expenses) based on AFT’s H124 performance, growing international momentum and potential upside from the upcoming launches in the US market (Maxigesic IV and Rapid). The H124 top-line performance was ahead of our forecasts, and we therefore adjust our FY24 revenue estimate upwards (to NZ$189.8m from NZ$184.0m previously). Specifically, we marginally raise and downgrade, respectively, our estimates for sales in Australia (NZ$112.9m vs NZ$110.1m previously) and New Zealand (NZ$47.5m vs NZ$48.9m previously), to reflect the H124 performance. For Asia and international markets, we make more aggressive revisions (Asia: NZ$11.2m vs NZ$9.9m previously; and international: NZ$18.1m vs NZ$15.2m previously) to incorporate the better-than-expected performance. Overall, we now estimate 21.2% y-o-y growth in FY24. We also tweak our FY25 estimates for the aforementioned reasons and upcoming launch of Maxigesic IV in the US and now project sales of NZ$234.1m (NZ$214.0m previously).

The H124 gross margin was 43% and we therefore adjust our estimates for FY24 (down to 45.0% from 47.2% previously) and FY25 (48.0% vs 50.3%, previously) accordingly. We expect the FY25 margin to benefit from the full flow-through impact of the US$3.9m milestone payment (AFT’s share) expected from Hikma in early-FY25. Operating expenses in the first half of the financial year were materially higher than our estimates (due to higher-than-anticipated marketing expenses in the domestic markets) and we therefore raise our full-year opex estimates to reflect this. Our FY24 operating profit estimate now stands at NZ$22.7m (management guidance-NZ$22–24m) and includes US$2.9m in reimbursement of regulatory fees from the FDA expected in H224. For FY25, we estimate operating profit to be NZ$40.3m, from NZ$41.0m previously.

Excluding leases, AFT closed H124 with a net debt position of NZ$30.6m (NZ$29.9m at end-FY23), which comprised NZ$6.2m in gross cash and NZ$36.8m in debt. The gross debt includes NZ$33.2m in term loans and a NZ$3.8m bank overdraft. The company holds an outstanding term loan with the Bank of New Zealand (BNZ), which was renewed in September 2022 into a three-year term loan maturing in April 2026. The NZ$33.2m term loan consists of an NZ$18.2m term loan, NZ$10.0m working capital facility and a NZ$5.0m business finance scheme loan (maturing in May 2026). In addition, AFT also holds an overdraft facility with BNZ, which was increased to NZ$9.5m on 15 September 2023 (up from NZ$3.0m previously). As of end-H124, AFT had utilised NZ$3.6m of the overdraft facility. We estimate that the company will end FY24 with a net debt position of NZ$27m, which translates to net debt/EBITDA of 1.1x, slightly ahead of management’s target of 1.0x.

We value AFT using a discounted cash flow (DCF) valuation methodology, projecting free cash flows over a 10-year explicit forecast period (FY24–33e) and thereafter ascribing a terminal growth value (assuming conservative 2% ongoing top-line growth and an EBIT margin of 36%). We have incorporated the H124 performance into our model and have made the aforementioned revisions to our near-term forecasts based on current trends, management guidance and operational visibility. In addition to our explicit forecasts, we have also upgraded our longer-term top-line estimates, to incorporate the potential growth opportunity from further international expansion, particularly in the US. The upside from this has been partially offset by a slower ramp-up to peak operating margin (36%), which we now assume in our model.

After incorporating these changes and adjusting for the latest net debt position, we adjust our valuation for AFT to NZ$723m or NZ$6.90/share from NZ$644m or NZ$6.14/share previously. We note that the company has disclosed its intention to declare a dividend for FY24, which we also reflect in our model (assuming a 10% payout ratio, in line with the 11% paid in FY23). We see this announcement of consecutive dividend payouts as a sign of strengthening business operations and improving cash flow expectations, a positive boost to investor sentiment in our opinion.

Exhibit 4 captures the sensitivity of our valuation to terminal EBIT margin and revenue growth assumptions.