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COVID-19 has had a net positive impact on demand for the company’s products; however, margins were impacted in the short term. The COVID-19 outbreak increased demand for Dermapharm’s branded pharmaceutical products, driven by the need to boost immunity. As a result, in Q1 2020, the vitamins/minerals/enzymes category witnessed a spike in revenue. Demand also increased for systemic corticoids. EBITDA grew at a slower pace than revenue, due to COVID-19-related production costs, expenses to set up the international business and increased marketing costs given the allergy season.


Management expected higher demand owing to the outbreak of the pandemic and built up inventory in the Parallel imports business, which enabled the company to meet the increased demand. In this business, EBITDA grew significantly faster than revenue, driven by a larger proportion of high-margin reimports. The Herbal extracts segment saw weak demand as a result of the COVID-19 crisis, mainly in the US and Spanish markets. EBITDA declined at a faster pace, as the company built up inventory in anticipation of higher demand following the opening of the lockdown.

Dermapharm’s main production facility in Germany was classified as critical infrastructure; thus, there was no disruption to operations. A prolonged pandemic will serve as a tailwind for the Branded pharmaceuticals and other healthcare products and the Parallel imports segments and as a headwind for the Herbal extracts segment. Margins should improve, as increased costs in Q1 2020 in the Branded pharmaceuticals and other healthcare products segment were one-off in nature.


Raw material sourcing not a concern


Dermapharm relies primarily on India and China for the supply of active pharmaceutical ingredients (APIs). The company has reassured there were no supply issues as of May 2020. It is confident there would be no supply bottlenecks. Allergopharma deal a perfect fit and strengthens the dermatologics portfolio.
 

The company completed the acquisition of Allergopharma’s European business on 31 March 2020. However, the closure of Allergopharma’s Chinese business is expected in H2 2020. Allergopharma is expected to boost the Branded pharmaceuticals and other healthcare products segment by adding complementary allergy products, thereby enhancing the company’s leadership position in dermatologicals in Germany. Allergopharma’s presence in 18 countries would also drive Dermapharm’s strategy to increase its presence in international markets.

Consistent positive free cash flow generation should enable the company to continue to generate shareholder value.

We expect Dermapharm’s net profit to ramp up much faster, clocking a CAGR of 19.9% over 2019-2022, driven by strong revenue growth coupled with margin improvements. This robust performance should allow the company to maintain steady capex over the next few years to drive its organic expansion. We believe Dermapharm should generate FCF of EUR 114m per year on average over 2020-2022, implying an FCF yield in the range of 3.9-5.4%. Strong FCF coupled with existing cash on the company’s balance sheet should enable the company to comfortably meet its debt repayment obligations and dividend payouts to shareholders through 2022. The company follows a policy of paying 50-60% of profits as dividends, which, based on our forecasts, implies a dividend yield of 2.0-3.0%.

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