Kalbe Farma

Most people assume that the pharmaceutical industry, just like other consumer industries, is resistant to the risk of economic slowdown, so companies in this industry should have a consistent financial performance from year to year, thus the stocks are also good for long-term investment. Because, logically, if you get sick, you inevitably have to drink/consume a particular drug, right? Even though the price of the drug is probably expensive.

While in fact, the pharmaceutical business is actually very different from other consumer goods businesses, say like the kind of daily necessities (soap, shampoo, toothpaste, etc.). A simple example: Every person, without exception, should shower and use soap every day, but not everyone should drink a medicine for cough/cold/fever etc., let alone to have to go to the hospital. And if someone drank a medicine and get cured, he is no longer need to buy the same medicine.

On the other hand, the production costs of medicines are not cheap. The costs of the pharmaceutical industry include labor costs (because it is usually labor intensive), the cost of raw materials (the companies still had to import most of it), the cost of research and technology, and costs for third parties such as profit sharing with pharmacies, hospitals and doctors. And if you think that pharmaceutical companies could generate large profit by selling prescription drugs at a price of hundreds of Dollars, then do not forget that they also produce generic medicines that cost less than US$ 1 per strip that contains 12 pills!

And consequently, in terms of profitability, the performance of Kalbe Farma (KLBF) et al is much lower than Unilever Indonesia (UNVR) et al, where ROE of KLBF was only 20 – 25% per year (or less) in average, compared to the ROE of UNVR which can reaches 100%.

Nevertheless, the ROE of 20 – 25% is pretty good already, especially if it could be achieved every year, and some big guys in pharmaceutical industries like Kalbe Farma (KLBF), Sido  Muncul (SIDO), and Kimia Farma (KAEF), their net earnings also rose steadily from year to year. Here is the data of net profits of nine pharmaceutical companies that is listed on the Indonesia Stock Exchange, between 2010 and 2014. Figures are in billions of Rupiah, the data are sorted based on the liquidity of shares of the company.

Company	2010	2011	2012	2013	2014
Kalbe Farma (KLBF)	1,286	1,482	1,734	1,920	2,065
Tempo Scan Pacific (TSPC)	489	566	628	635	579
Sido Muncul (SIDO)	237	340	388	406	415
Kimia Farma (KAEF)	139	172	205	215	235
Indofarma (INAF)	13	37	42	(54)	1
Pyridam Farma (PYFA)	4	5	5	6	3
Merck (MERK)	119	231	108	175	181
Taisho Pharmaceutical (SQBB)	93	120	135	150	165
Darya-Varia (DVLA)	111	121	149	126	81

And now here’s the problem: Maybe because most of investors consider that the pharmaceutical business has a low risk so that the net value pof KLBF et al should be rising steadily in the long term, and that their profitability is as good as UNVR (but it is not), the valuation of stocks in the pharmaceutical sector are quite high, including the PBV of KLBF had been above 8 times, and its PER was more than 40 times. And at first I also thought the same: Pharmaceutical stocks are worth to be bought at premium price, because they are wonderful company that always have bright prospects for the long term.

But after seeing TSPC, the second largest pharmaceutical company behind KLBF, had a declined earnings since last 2014 (and this year their earnings still dropped), that’s when I have become aware that the risk of the pharmaceutical business is greater than the risk of any other consumer businesses, whether it is related to the increase in labor costs, the impairment of Rupiah which automatically raise the price of imported raw materials, until risk due to intense competition (try to name the brand of drugs for headaches, fever, and cough, a lot of brands, huh?). The stock of TSPC itself, after it was valued at PBV 7 – 8 times at the price of Rp5,000 per share, two years ago, it fell continuously until now its PBV was already less than 2 times, aka the same as the valuation of most stocks in general.

KLBF current valuation = Overvalue

KLBF is one of my top holdings in the past, precisely in 2010 when I acquired it at the price of Rp2,200 per share (equal to Rp440 per share after stocksplit). And it was successfully rose, and continue to rise until I sold it a few months before it reached a price of 7,500 (equal to 1,500 after stocksplit) in 2013. However, at the price of 1,500 I refused to buy it back even although the stock continued to climb until reaches 1,900 at the beginning of 2015. And that’s because, I still remember, at the price of 440 in 2010, the PBV of KLBF was still about four times, or relatively fair/low when considering the big name of the company, the good liquidity of its shares, company’s excellent track record of performance, its ROE that was nearly 30%, and that the average PBV of consumer stocks were above 5 times.

While in 2013, when KLBF stood at 1,500, its PBV was 6 – 7 times, while its ROE declined to about 20 – 22%. Let say, you still think that KLBF is cheap at that price, and indeed the stock still able to gained until 1,900’s, where its PBV had been above 8 times, two years later, because in these two years, the company still able to generate growing earnings. But here’s the risk: If later KLBF has its earnings decreased, as TSPC already had, it is very likely that the stock would fall until its valuation become the same like most of the other stocks, ie PBV 2 – 3 times, or less.

Thus, although in the last few months KLBF continue to fall from 1,900 to 1,300 as today, but since its PBV is still 6.5 times, I assume that the price is not low enough to buy. Only indeed, in value investing you need to see at the company's performance first, then the valuation of the shares. When the Jakarta Composite Index (JCI) was dropped in second half of 2013, KLBF also dropped from 1,540 until bottomed at 1,180 in December, and at the price of 1,180, its PBV still 6 – 7 times. But probably because of company’s performance in 2013 was still good its where profits still growing significantly compared to 2012 (see again the table above), then when the JCI rebounded in 2014, KLBF also rose until peaked at 1,900 in May 2015, or gained more than 50% within one and a half years.

Then how about for this year of 2015? Well, until the third quarter of 2015, KLBF’s earnings still rising but only 0.8%, so the current condition is somewhat different than 2013. If later in 2016 the JCI go up, KLBF may also go up, but it won’t make 50% profit like a year ago. On the other hand, if its performance in later quarters turned out to be not as expected, for example its net earnings dropped, then the stock may fall like TSPC.

In conclusion, although KLBF may offer profit opportunities in the medium term, but the risk is relatively high, particularly related to its valuation that is not low enough. So I don’t think that it worth to buy. Some people say that, since KLBF recently began to invest into segments of FMCG (fast moving consumer goods) by producing beverages, nutritional foods, and other daily necessities, then it is now look alike UNVR, and that justifies its high valuation, and remember that its parent company, the Kalbe Group, also has expanded into hospital busniess (Mitra Keluarga/MIKA). However, I would say, as long as the performance of KLBF is still not too special like today, I don’t care what are the management doing, I will not value the stock too high.

PT. Kalbe Farma, Tbk.

Rating of Performance until Third Quarter 2015: A

Rating of Stocks at 1,355: BBB

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