Aurobindo Pharma: The right mix

Investor concerns about the pharma sector and a somewhat subdued December quarter contributed to a 22 per cent dip in the stock of pharma major Aurobindo Pharma, since October 2016. This correction presents a good buying opportunity for investors with a long-term perspective. The stock’s valuation is attractive. At ₹674, it trades at about 17 times the trailing 12-month earnings — a 15 per cent discount to its five-year average.

The company’s growth prospects look robust. Its strong presence in the US market, several launches and healthy product pipeline, improvement in the European business and comfortable debt levels should spur revenue growth and margin expansion.

Over the years, Aurobindo Pharma has made a successful transition from a manufacturer of active pharmaceutical ingredients (API) to a formulations major. Close to 80 per cent of the company’s revenue now comes from the formulations business and the rest from APIs.

The company has a wide geographic footprint with marketing presence in over 150 countries; international business contributes nearly 87 per cent of the revenue.

The US is the major market, accounting for about 45 per cent of sales. Huge manufacturing capacity with 22 facilities and a robust product portfolio across seven major therapy areas (antibiotics, anti-retrovirals, CVS, CNS, gastroenterologicals, anti-allergies and anti-diabetics) have helped the company launch several products and scale up rapidly over the years. The company is also expanding in new segments, such as bio-similars, which have high potential.

Unlike many large-cap peers, none of Aurobindo Pharma’s manufacturing facilities faces regulatory action currently. In January 2016, the company’s Unit VII in Mahaboobnagar in Telangana received some Form 483 observations from the US regulator FDA. But this was resolved later with the issue of the Establishment Inspection Report (EIR).

Despite challenges such as regulatory embargo on some units in earlier years, Aurobindo Pharma has grown rapidly in the key US market. Revenue in the geography grew at an annual average of over 80 per cent between FY12 and FY16. This has been aided by several launches over the years in diverse categories, including injectables, ophthalmics, specialty products and controlled substances.

The US revenue grew 37 per cent year-on-year in FY16 but moderated in the recent quarters. The US formulations business witnessed 17 per cent growth year-over-year in the nine months ended FY17. This is because of the increasing competition and pricing pressure in the oral solid business. But this should be offset by launches in the injectables business, which has been growing strongly and is expected to maintain momentum.

With multiple filings and expected launches, the management expects the injectable business to grow 50 per cent y-o-y for the next few years. The company’s focus on the US market remains high with 421 Abbreviated New Drug Applications (ANDAs) currently. This is one of the largest pipelines among Indian peers.

The company is also increasing its presence in niche high-potential categories, such as oncology, hormones, peptides and biosimilars. This should pay off in the coming years. Besides, the acquisition of supplement-maker Natrol Inc in 2014 has given the company a presence in the nutritional over-the-counter market that is expected to grow strongly.

In the other key geography, Europe, that accounts for more than a fifth of revenue, the company has expanded its presence through the inorganic route. In 2014, Aurobindo Pharma acquired the Western European operations of Actavis in seven countries, and in 2016, it acquired Generis Farmaceutica SA in Portugal. Other acquisitions include Milpharm in the UK and Pharmacin International in the Netherlands. The company recently bought four biosimilar products from Swiss firm TL Biopharmaceutical and plans to start clinical trials for one of them this year. These initiatives could pay off well in the medium to long term.

The Actavis acquisition turned profitable last fiscal with cost control and product rationalisation. Costs should reduce further with the company being in the process of transferring product manufacturing from Europe to India. The company has transferred 63 out of 114 products as on December 2016. Shifting of the remaining products should aid margins in the medium to long term. After a mild contraction in sales in the geography in FY16, the company has done well in FY17.

Business in emerging markets, such as Middle East and North Africa (MENA), Brazil, Ukraine, Mexico, and South Africa is also growing at a healthy pace.

With several acquisitions and the company in expansion mode, debt has increased over the years. Leverage level increasing sharply was a cause of concern. But with growing profit and loan repayments, the debt-to-equity is now at a comfortable 0.5 times or so. This gives it enough headroom to fund future acquisitions. The management has indicated that debt will be around $600 million as on FY-17 against $640 million as on FY-16.

The company’s consolidated revenue grew about 13 per cent y-o-y in FY-16 to ₹13,651 crore while profit grew more strongly at about 26 per cent to ₹1,982 crore. In the nine months ended December 2016, while revenue grew 12 per cent, profit expanded at a faster 20 per cent. Improvement in margins due to cost-control measures has aided faster profit growth. Operating margin improved to 24.4 per cent in the nine months ended December 2016 from 23.6 per cent in the year-ago period.

The company plans to increase its focus on research and development (R&D).

From about 3 per cent of sales currently, expenditure on R&D is expected to rise to 5-6 per cent of sales in the coming years. This should aid launches, revenue and profitability in the coming years even if margins moderate somewhat in the near-term.

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