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International Conference

The 13th ICMSS

Investment Analysis

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Sampoerna School of Business

PT Kalbe Farma Tbk.

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Date: December 13rd

,2013 Current Price: IDR 1,200

Ticker: KLBF-JK USD/IDR: 11,999

Recomendation : BUY Target Price : IDR 1,544 Potential Upside : 28.67%

Highlights:

Income Stock With Sustainable Business Strategy

As Indonesia annual health care expenditure is expected to be

increase to US$ 60.6 billion, that makes it tobe the sixth largest

health care spanding in Asia Pacific in 2018. The number came

from many assumptions like increasing GDP and rapid increasing

in middle class. Then, the National Healthcare Insurance (NHI)

one of decision that made by government will become another

challanges and opportunities for KLBFthat planned to cover domestic population in 2019. As strong fundamental that own by

KLBF we recommend strong BUY for KLBF.

Buy recommendation based on valuation and fundamentals:

Kalbe have target price of Rp 1,544 by 2014, with increase on revenue

of 15%. As the income stock, Kalbe have dividend payout ratio of

44% with regular increase on the amount dividend paid that predicted

to be Rp 74with 85 billion outstanding shares. Kalbe has shown high

liquidity and inventory turnover.

Sustainable strategy that ensure robust growth:

Kalbe made acquisitions and joint venture with strategic companies

that increase their net sales over time after the acquisition takes place.

Kalbe also aggressively buy depleted trademarks and patents to

increase their own portfolio. Last strategy is stem cell and cancer cure

institution that turn Kalbe as the game-changing companies in stem

cell and cancer research.

Market leader that will sustain its superiority:

Over the decade, Kalbe has become the leader in Indonesia

PT Kalbe Farma Tbk.

Pharmaceutical Industry

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pharmaceutical industry with market share of 12% with 50.78 billion

share outstanding.

Business Description

Indonesias and Southeast Asias Largest Publicly-Listed Pharmaceutical Company. Established in 1966, located in Jakarta,

Indonesia, PT Kalbe Farma Tbk. is one of the largest players on

pharmaceutical industry in Indonesia. The Company went to public in 1991

and currently holds 52.28% shares (Figure 1). Under management of Kalbe

Farma, the four segments which are :

Distribution and Logistics, Prescription Pharmaceuticals, Nutritionals

and Consumer Health have successfully led the market positions with

more than IDR 67.03 trillion of market capitalization in 2013. We identify

the biggest strength of the Company to be quality of its products,

quantity of production facility as well as research and development

institute, effective marketing and sales, and good consumer

relationship. To strengthen their international position, Kalbe Farma is

currently engaged in a Stem Cell and Cancer research with their own

institution named Kalbe Genomix. As a holding, Kalbe Farma comprises

22 subsidiaries. However, the core business of Kalbe Farma is Distribution

and Logistics which contributed to 37% of Group revenues and 23% from

Prescription Pharmaceuticals division in year 2012 (Figure 2).

Strong Brand Equity with Leading Market Position. Along its

subsidiaries, Kalbe Groups currently the #1 highest trademarks owner for product portfolio for more than 1,027 of trademarks (exclude patents and

formulas) and dominating 13% of the total market share (Figure 3). Kalbe

Farmas strong brand name is not only result the Company to have good reputation with the highest share of total market but also positions each of

the four segments as the market leader. The Company exports its products

for 96% to domestic market and 4% to Southeast Asia and several African

countries (Figure 4).

Current Strategy of the Company can be described with the following 5

pillars:

Expediting Go Global main goal is to achieve Global Brand for all business segments. Possible solutions are through more aggressive product

launching and strengthening distribution network in the global market, and

build production facility in new territories globally.

Strengthening Business Portfolio the idea is to increase the revenue simultaneously halt the unit cost of production. Considered solutions are

through innovative products development, increase merger and company

acquitting, and introduce products for drugs that have reached their patent

expiration dates.

Improving Sales and Marketing strategic goal of reaching mass market segment and to achieve better product availability. Solutions are opening

new market opportunities, expanding the presence of Mitrasana Clinic in

minor area in Indonesia as well as to global area, and building more

branches and warehouses.

Developing Competent Leaders with Panca Sradha Kalbe Character main goal is to have Companys personnel who are collaborative, assertive, passionate, and competent. Solutions are establishing more research

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institutes, and improving the quality of their education institute called

Kalbe Farma School of Business and Technology.

Managing Working Capital Effectively main goal is to have sustainable working capital to increase the quantity of products. Solutions

are having strategic raw material sourcing, labor outsourcing from

countries with low cost of wages, and investing in new technologies and

process.

Kalbe Farma management comprises only professionals. Currently,

management of Kalbe Farma consists of 5 persons. The CEO is Bernadette

Ruth Irawati Setiady, M.Sc. (Forbes Asias 50 Women In the Mix). She has served as the chairman of management board since 2008. Under her

leadership, Kalbe Farma successfully obtained status PROPER Blue

category from Indonesia Ministry of Environment. Other 4 members of

management have wide experience in either pharmacy, food science:

Herman Widjaja or are experts in planning and finance projections: Ongkie

Tedjasurja, Vidjongtius, and Budi Dharma Wreksoatmodjo.

Corporate Governance and Social Responsibility The company shows good result in creating transparency to the corporation

and shareholders. Moreover, Kalbe also show good CSR program, shown

on their willingness to engage to the social and also ecological

improvement

Corporate Governance Kalbe has developed whistleblowing system and transparency to the

shareholder. The company shows good effort on creating good corporate

governance system.

Corporate Social Responsibility Company reflected good CSR from the report. Kalbe engaged in various

acts in ecological and social engagement. On ecological side, Kalbe

invested on several programs to improve their

waste management and energy reduction. Kalbe received full mark on

Performance Rating of Environmental Management from State Minister of

Environment of Indonesia.

Industry Overview and Competitive Positioning

Macroeconomics Overview

Intermediate Economic Growth and Attractive Demographic

Profile.Indonesias economic outlook remains positive but having a slight slowdown. Based on World Bank forecast, Indonesia GDP growth will be

reduced into 5.6% on 2014, from previous forecast of 6.2%. Economic

slowdown is occurred as the result of external financial pressures and high

cost on fuel subsidies, making it sensitive to the level of Rupiah. In spite of

the slowdown, the growth is expected to be greater than 5% (figure 5.1)

World Bank also predicted that inflation on 2014 would be on average

level of 7.3%, as the impact of election and fuel subsidy.

However steady domestic consumption, robust investment climate and

accelerated infrastructure development will give beneficial traits to invest

in Indonesia. Accelerated infrastructure development is shown on the long

run projects that are started on 2013 such as airports, MRT, and toll

roads.This positive projection expansion of middle class segment has been

increasing over time. According to data from World Bank and IMF,

Indonesias population growth has been experiencing an increase from

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2008 to 2012 (Figure 6) of an average by 1.2%, followed by increase of per

capita GDP shown in figure5

Forecasted future economy has shown a green light. The increasing of

consumption growth of Indonesia benefits the pharmaceutical industry in

the country. This forecasted outlook is ignited by Indonesian governments new plan, called Master Plan for Acceleration and Expansion of

Indonesias Economic Development (MP3EI) that aims to put Indonesia as one of the top ten biggest global economies by 2025, spanning the years of

2011 to 2025 and creating six main economic corridors. This scheme also

means a primary investment in infrastructure to improve and continue

supporting industries. World Bank, IMF, and Asian Development Bank

have forecasted an explicit economic viewpoint in regard of this countrys future GDP growth.

Pharmaceutical Industry

Prosperous market driven by strong domestic demand and

consumption. In consequence of the lack of health issue penetration within

the country of around 250 million people, Indonesia still positioned the

lowest for total expenditures on health compared to other ASEAN top

members with average only 2.6-2.7 percent of its GDP, with an estimated

value of 7.31 billion USD in 2012. However, due to the countrys large population with high local demand and consumption for medicines and

drugs, Indonesias practically small but rapid type in pharmaceutical market is expected to grow at an annual growth rate of 10.8%, reaching a

value of 12.2 billion USD by 2017 which will be positioned as the sixth

largest pharmaceutical market in Asia-Pacific region.

As Indonesias population tends to increase along with the consumer spending, prosperous pharmaceutical industry is promised. Higher than in

2012 which had 47 trillion rupiah (around $4.865 million), the

pharmaceutical products sales in the market is domestically predicted to attain 50 trillion rupiah (around $5.173 million). Furthermore, Indonesias comparatively strong production level that is boosted by generic drugs

demand triggers the growth of pharmaceutical and healthcare market. The

system of consolidation that has been likely formed in the country where

powerful companies maximizes their profits by acquiring smaller domestic

businesses also contributes in the part of this growing industry.

The Ministry of Health and Universal Health insurance access

healthcare services. Indonesian central government including Ministry of

Health (MOH) are setting up for the project of increasing number of

hospitals and hospital beds in the country by 100,000. Presently, the

availability of hospital beds in Indonesia is only 6 with just 3 physicians

for every 10,000 people, with a ratio of around 1:7 compared to US. This

development is expected to increase the value of pharmaceutical and

healthcare industries in this country, from $24.5 billion to $49 billion. Due

to the improvement of Indonesias primary healthcare system, workers, and facilities, the MOH is taking out more than $3.27 billion in 2013.

The system of Universal Health Insurance, which is aimed to cover

Indonesias total 237 million people by 2019, is planned to be launched in 2014. This governments movement bridges healthcare service and distribution of drugs and medicines all around the regions, and will

eventually increase the countrys health expenditure which will drive the

Figure 5.1 : Indonesian GDP Growth

Source: Teams Estimation

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pharmaceutical industry to a better view.

Competitive Positioning

Bargaining Power of Supplier (5/5) Kalbe Farma and other pharmaceutical companies outsource the supply from foreign supplier. Suppliers have the right to dispose Kalbe if there are adjustments to the prices due to the changes in foreign exchange and the companies dont want to follow the adjustments. Suppliers are also able to change their business partner if the partner is not profitable. Bargaining Power of Customers (4/5) Customers have a freedom to choose the best pharmaceutical product for OTC and consumer goods market. In spite of the freedom to choose, most of Kalbe Farmas product lines are customer favorite, shown by the number of Top Brand awards given to the products in their line. Threat of New Entrants (2/5) Pharmaceutical industry has a strong barrier to entry for new business. Taking capital as the consideration, new companies need to invest a lot of capital in order to start competing in the industry. Lab, manufacturing plants, research and development, and patent needs substantial amount of capital. Moreover, major pharmaceutical agents mainly control distribution line to the drug store. On the legal side, according to Ministry of Health Order Number 1799/Menkes/PER/XII/2010, companies must finish the assessment and gain approval from Ministry of Health of Indonesia. Strict Requirements and assessments that were implemented by Ministry of Health halt the entry of new businesses. Threat of Substitution (3/5) In terms of substitution of Kalbes product, Kalbe has diverse perspective based on the range of the product portfolio. On the prescription drug perspective, doctors and pharmacist show big trust to choose Kalbes product, ensuring Kalbes domination. Over The Counter medication is based on consumer preferences. Kalbe has shown consumer trust from the products that achieved Top Brand Platinum for OTC medication like Promag. In spite of consumers that have freedom to choose the similar product from the competitors, consumer choice is mainly based on trust and personal preferences In the consumer health division, consumers have more freedom to choose the substitution of product. Taking example on multivitamin, Kalbe have Fatigon and Tempo Scan Pacific, their competitor have Hemaviton. Both products have similarities and gained public trust, seen on Top Brand that was awarded to both goods. From the example, we can see that substitution in pharmaceutical product is on the fair scale, weak for the prescription drugs but medium on consumer health and OTC drugs Rivalry in Industry (5/5) Fierce and intense competition can be found in Indonesia pharmaceutical industry. Kalbe competes with companies like Dexa Medica Group, Sanbe, Soho Group, Pharos Group, Tempo Group, GSK, Kimia Farma and other companies. In spite of the tight competition,

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Kalbe shown an outstanding performance in terms of market share in Indonesian pharmaceutical industry by more than doubling the shares than the competitor Pharmaceutical industry shows rapid innovation among the competition member. Taking an example from cancer medication, companies are researching for the best cancer medication to gain their competitive advantage. In a decade, pharmaceutical companies in Indonesia have their own cancer medication like Kalbe with TheraCim, Merck with their Erbitux, and Shering Plough Indonesia with Intron and Temodal. Vast growth and competitiveness indicates that rivalry among competitor is tough

Investment Summary

We suggest (strongly buy) recommendation for PT. Kalbe Farma

(KLBF.IJ) with target price (IDR) and upside gain about (28.67%) from its

current market price of IDR 1,200. The company is market Leader of

prescription pharmaceutical with market share of 13% among its other

competitors. The companys product has been distributed in 100% hospitals and drugstore in Indonesia. In 2012, The Company is experienced

growth 25% in its total revenue and in 2013 the revenue is expected

increase about 15%.

Our team believes there are many investment keys that have been

appreciated by market. KLBF stock categorize as Income Stock since the

stock offer positive-increasing dividend every year. The company earns

from existing products, potentially earn from future projects and

development, leader between its peers in pharmaceutical industry.

Income Stock. The KLBF stock is categorized by us as income stock since

the company pay increasing amount of dividend every year. The dividend

payout ratio of the company is not constant; recently in 2012 the dividend

payout ratio is 44%. Then, even the price is relatively stable in Indonesias currency downswing recently; we cannot categorize the stock defensive

stock. The KLBF Beta is 1.1 that indicates the stock is not defensive since

it gives 10% return. Even, the company can hold its price in current

currency issue, it is not indicates that the stock is defensive stock since the

company imports about 95% its material using forward contract every 4

months. So its also one of company way to diversify risk.

Increasing of Population. The increasing population and health

expenditure that spend privately has positive-modest correlation of 44%.

The percentage proves that positive growth of population will affect

pharmaceutical-health care industry positively. Furthermore, there is also

positive correlation between increasing GDP and health-private

expenditure of 34% that will give positive effect to the industry.

Positive Growth of Dividend Payout. Kalbe Farma is income stock that

offered positive growth dividend every year. There is positive correlation

within dividend payout and companys net income of 91%. As the characteristic of defensive stock of KLBF that is not going to be affected

by economy downswing, we expect the net income will grow of 21% from

previous year and we estimate the dividend payout will grow 16.5% next

year as the consequence.

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Innovation stimulates positive growth. Positive growth is the aim as

company that can be achieve in 2 major ways. Those ways are innovation

in developing new products and acquisition. The companys product innovation by company is done by increasing developing capability that

supported by brand repositioning, packaging improvement and

modernization, Promotion and increasing the availability of product.

Today, the company has more than 380 brand names, and it is expected

increasing as every year the company launch new product every year. The

mergers and acquisition is done by company to increase their market share.

So far, the company has 22 subsidiaries that run their business and four

segments and the number of subsidiaries is expected increase every year.

The company is going to strengthen the existing expansion plan in ASEAN

to reach 500 million people through joint venture, subsidiaries or

establishments.

Strengthen Regional Market. The companies are going to expand their

distribution networking through opening central of regional distribution

and new branches, the company are going to increase the branches capacity

and their facilities. In 2014, the company plans to expand its market to

Myanmar and Vietnam and expected to contribute almost 8% to the

Companys net sales.

Appealing Valuation with Buy Recommendation. We obtain the Kalbe

Farma Stocks will be worth IDR 1640 using DCF method. The reason of using the method is the company are pharmaceutical company with cash

basis and the method can be implemented in over all sectors. The stocks beta is 1.1 than indicate the companys stock will give return about 0.1.

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Valuation

With current market price of IDR 1,200 (December 13, 2013), we

estimated the target price to be IDR 1,544 with potential upside gain

28.67%.

DCF Valuation Method for KLBF

We used the valuation model using Discounted Cash Flows (DCF). DCF

Valuation will be appropriate for valuing KLBFs stock as its business of pharmaceutical in which the transaction is usually cash basis. It is believed

that The Company has a sustainable business that could maintain the Free

Cash Flows to be grow.

The 5-year projected Free Cash Flows, Capital Expenditures, Discount

Rate, and Continuing Value are our consideration to build a strong

valuation model.

5- Year Sales Forecast

The sales forecast was estimated by the expansion of The Company in

acquiring other pharmaceutical companies. The companys net sales expected increase of 15.5% every year. In 2013, KLBF will be expected to

generate IDR 15,750 billion from net sales through the aggressive

expansion. We estimate a 9.10% growthof net income in 2013 revenue

CAGR FY 2011-17.

Capital expenditure

The CAPEX would be forecasted to be IDR 3,671 billion from 2013 to

2017 for financing KLBF expansion and investment. The CAPEX

distribution goes to build new factories, distribution expansion, and

investment on other asset.

Continuing Value

Our teams estimation suggested the perpetual growth of 14%. The percentage is calculated from multiplication of 5 year average of ROE and

Retention Rate. The continuing value is expected to be IDR 143,625

billion.

Discount Rate

We used WACC as the discount rate since the average Debt to Equity ratio

was maintain to be 27.76% every year in average. We assume that KLBF

will always maintain its DER in that percentage. The WACC is 15.45%

with the cost of debt 8.79% and cost of equity 17.30%. Our teams estiamation also predict the market return (IHSG) was 16.57% and risk-

free at 9.27% (SUN matured in 2014) with companys beta of 1.1.

Financial Analysis

Revenue: Based on the historical data, the biggest growth of revenue is experienced

by company in 2012 with 25%. We indicate that in 2013 2017 the revenue growth will be 14.89% every year. Furthermore, there are many

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reason that will support the increasing of revenue growth, such as

increasing of population, GDP and private spending for health and the

company portfolio.

The company portfolio, the key of Kalbe Farmas growth. The company portfolio in acquisition is one of Kalbe Farmas way to increase their market share since they will also taking over all products under the

company, like in 2012 the Kalbe Farma Company acquire PT Hale

Internationala juice producer company, the acquisition of PT Hale also first step to make an alliance between both of them to establish PT Kalbe

Milko International.

Increasing of Population, GDP, Private Spending for Health. Our team

indicates the increasing of population is 0.4% every year and the GDPs growth is 1.1 every year. As a result of increasing GDP, the private

spending for health also increasing every year. The growth of them, will

affect the sales of company that run their business in pharmaceutical

sectors.

Earnings: Increasing Net profit margin. The increasing of net profit margin cannot

be separated by the companys way to diversify the risk by portfolio. The net profit margin in 2008 -2012 is 12.5% and it is expected increase to

13.11% in 2013 to 2017.

Cash Flow:

The cashflowofcompany isexpectedincreasingyear to year.In 2013,the

companys free cashflow is expected IDR 849 billion. However, the growth is decrease about 21% from 2012.

Financing:

Debt to Assets ratio of the company is 20% in average, KLBF

expected will get easy accessto get loan when the comoany need

financing. The debtor will have no doubt as in average the company

current ratio is 3.5 and its capability to pay is 150 in averagecalculated using Times Interest Earned Ratio. Then supported by its

currentcash conditionand the debt coverage ratio the company can

finance its project event the project is huge.

Investment Risk

Economic Risk

IDR-USD exchange rates fluctuation Approximately 95% raw materials of the company are acquired by

importing from producer countries. When Rupiah weakens, raw materials

price is increasing due to the foreign exchange and Kalbe must do some

adjustment prior to the increase or they will face lost. Kalbe made 4

months future option contract with the producer to prevent the exposure

foreign exchange risk.

Operational Risk

Escalation on state minimum wages On 2012, state minimum wages are increased substantially from the

government regulation. Increase on state minimum wages will increase the

production cost by the number of the labors. Kalbe put their plant on the

regions where the minimum wages are still low

Supply chain disruption

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Having wide distribution line, Kalbe distribution line can be disrupted by

natural disaster and human factor like floods, landslide, and labor strike.

Disruption will create a snowball effect to the company due to the shortage

of goods. Kalbe has preparation for the disruption by sending the goods

from other branches

Labor strike Over the last year, there are plenty labor strikes that occurred in Jakarta and

other region. Labor strike will reduce the productivity of the business and

cut of the distribution line. Kalbe gives fair compensation and benefits to

the employee in order to prevent labor strike. Moreover, Kalbe laboratories

are located in places where labors are rarely got into the street

Acquisition on unbeneficial company Kalbe is actively acquiring companies as their strategy to gain competitive

advantage. There is a possibility of Kalbe to acquire company that will

bring Kalbe group down because of the performance. Kalbe has set up high

standard and deep research on the companies to ensure the future success

after the acquisition

Political Risk

Government policy on pharmacy business Government regulations have big impact on the pharmacy business.

Government can set up the policy to increase both prescription and generic

drugs. Kalbe has prepared to the effect of price increase by the trust from

doctors and pharmacists that usually choose product from this company

Possible ban on stem cell research Countries like Austria, Italy, Norway, and Poland set restriction on stem

cell research due to the ethical issues. Stem cell research is one of the

spearhead of the industry that will face great loss if Indonesia government

restricts stem cell research. Kalbe set the stem cell research institution in

Indonesia and Singapore that give supports to the research.

Delay on Universal Social Health Program Indonesian government is preparing universal social health program by the

year 2014. If the government delays the program, companies wont get an extra income from the sale of the medicine that is used. Kalbe might not

have the sales increased if the delay happen, but the present sales indicates

that this company have strong sales.

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