Research Note Morgans commencing broker coverage and has a buy

Morgan's has a very detailed Research Note. Below is the condensed version.

Probiotec (PBP) PDF A defensive pharma manufacturing growth play ADD (initiation) | Target price: A$3.30 | Current price: A$2.16

Probiotec (PBP) is a leading Australian manufacturer, packer and distributor of third-party OTC and prescription pharmaceutical, consumer health and FMCG products. The company services 200+ domestic and international clients including several tier-1 brands such as GSK, J&J, Blackmores, Nestle, and Unilever. PBP operates in the relatively defensive market for essential health and consumer products and is well positioned to benefit from near to medium-term sectoral tailwinds driven by greater demand for manufacturing sovereignty and supply chain security within the pharmaceutical industry. Planned site consolidation and potential M&A may also enable further scale and operating benefits. We initiate coverage with an Add recommendation and a 12-month target price of A$3.30/sh based on our DCF valuation.

A leading manufacturer of OTC pharmaceuticals with robust tailwinds Customer contracts and relationships offer defensive revenue profile: PBP has +200 clients with ~70-75% of revenues contracted on long terms of 3-5 years (7+ years with extension options), and a high renewal rate. This strong long-term relationship with customers provides a clear line of sight for future revenue. Onshoring of pharma manufacturing/packing presents medium-term tailwinds: Various pharmaceutical brands are seeking to shore up supply chain sovereignty in the wake of COVID-19 disruptions. With ~85% of OTC medications manufactured off-shore (China/India), small increases in domestic manufacturing market share represent a material revenue opportunity within the space. Cold and flu rebound supporting revenue recovery: In FY21 PBP's revenue relating to cold-flu medication contracted by $21m due to the low prevalence of symptoms and transmission during COVID-19 lockdowns. While this has partially recovered during FY22, ongoing recovery in PBP's manufacturing volumes still represents a tailwind for the company into FY23, with the segment expected to reset above pre-COVID levels in the short term as demand/stock levels normalise. Consolidation and M&A to drive greater scale: We see further scope for PBP to deliver incremental scale and utilisation to its core business through accretive M&A opportunities in line with historical acquisition multiples of 4-6x EBITDA. Analysis and forecasts Earnings growth: We forecast an EBITDA CAGR of c.11.8% (FY22-25F), driven by customer and contract pricing/volume growth and sectoral tailwinds. While near-term margins softening is expected, contract repricing should recoup cost inflation. We forecast FY23 EBITDA growth of +5% to $34.4m, which we see as achievable in light of PBP's near-term guidance for 1H23 revenue of $100-$105m (+17%-23% YoY) and EBITDA of $15.5-16.5m (+4%-11% YoY). Cash flow conversion: PBP has historically delivered cash conversion of c.60%, a trend which we expect to continue. PBP will see a modest step-up in capex in FY24-25F as it invests in its new Kemps Creek Site, although this will normalise from FY25F and enable improved operating margins in future. Balance sheet well maintained: PBP held net debt (ex. leases) of $26.3m as at Jun'22, representing conservative net gearing (ex. leases) of 33%. Net-bank debt/EBITDA at ~0.8x and interest cover of 5.4x are also well maintained. Investment view and valuation We initiate coverage with an Add rating and $3.30/sh target price, reflecting 53.0% upside potential and a 2.0% FY23F dividend yield (c.100% franked). Risks Contract/customer renewals: PBP actively manages pricing and volumes across a portfolio of long-term customer contracts, but remains exposed to contractual changes, renegotiations, and potential terminations. Regulation/licensing risk: Manufacturing of pharmaceutical goods is regulated by the Therapeutic Goods Association (TGA) in Australia. Failure to maintain or renew PBP's various licences/accreditations may impact its manufacturing ability. M&A and site consolidation: Future earnings growth is partially reliant on cost savings associated with the successful consolidation of its NSW operations. Failure to do so to budget and in a timely manner may impact PBP's future returns.