Aventis Pharma: Buy

If M&As offer a short-cut to growth, then Aventis Pharma's recent acquisition does promise to put it in a high-growth orbit.

For a company that's grown only at a modest rate in the last few years, the acquisition of Universal Medicare's marketing and distribution business in India marks a significant milestone.

While the acquisition per se isn't very significant in terms of the likely revenue addition, it would mark the entry of Aventis in the high-growth OTC and nutraceuticals segments.

That the parent company chose to route the acquisition through its listed subsidiary is also a positive, as it benefits all the shareholders of Aventis alike.

The double-digit growth registered by Aventis in its domestic segment in the first half of the year also underscores its strengthening prospects.

Investors with a long-term perspective can, therefore, consider accumulating the shares of Aventis Pharma.

At the current market price of Rs 2,236, the stock trades at about 22 times its likely CY-12 per share earnings (two-year average PE is about 23 times). While this isn't cheap, the company's entrenching domestic presence, a healthy balance sheet with little leverage and cash surplus add in its favour.

Growing Wellness

Considering that Aventis had for some time been on the prowl for acquiring OTC brands, the acquisition of Universal Medicare's business doesn't come as a surprise.

Besides, the move is in sync with the growth strategy of Sanofi, a majority stakeholder in Aventis Pharma, as it will allow both Aventis and the Sanofi Group to reach out to larger sections of the populace through its broad product offerings.

Universal Medicare boasts of portfolio of over 40 branded formulations, which include the cod liver oil capsule, Seacod, vitamins, mineral supplements, primarily antioxidants, anti-arthritics, anti-osteoporotics, liver tonics, and other nutrients.

The size of Universal Medicare's business that will be acquired is about Rs 110 crore. Reports, unconfirmed by the company, peg the deal at about Rs 500 crore (deal valuations at about 5x sales).

Besides helping Aventis grow its presence in the burgeoning OTC segment, where it currently has only a negligible presence, it would also help the company reduce the impact of the drug pricing control on its revenues; the OTC segment doesn't come under the drug pricing control's ambit.

As per the agreement, Universal will continue to manufacture the products, even as over 750 employees from Universal move onto Aventis Pharma (currently 1,900 field agents). Larger field agent strength would help the company further improve its reach.

Funding the deal wouldn't pose much of a challenge, considering that the company had ended the first half of the calendar year 2011 with cash of about Rs 514 crore. With little debt on the book, the company also has room to raise debt, if required.

Domestic presence

While the growing domestic market has a wide appeal, the going has been tough for pharma companies in the last couple of quarters. Higher competition and lower productivity of the added field agents have been a drag. But even as this impacted some of the entrenched players, which found it difficult to grow over the last two quarters, Aventis managed to post 12.3 per cent growth in the domestic segment (six months to June 2011). This highlights the company's strengthening domestic presence, helped by a basket of popular products and aggressive marketing initiative.

Its products such as Combiflam, Cardace, Allegra, Amaryl, and Lantus, which have been top contributors for the last three years, are among the top 100 brands in the Indian pharmaceutical market. Increasing focus on cardiovascular system and diabetes therapies too has helped (launched new division ONSITE to support this). Its rural initiative Prayas, through which it is building capacity in rural India, has also helped the company make its mark in Tier-III and IV cities. As of December 2010, the company had expanded its presence to 14 states and had over 10,000 doctors in its network.

Earnings scorecard

Over the last five years, Aventis' revenues and adjusted profits grew at a compounded rate of about 6 per cent and negative 1.7 per cent respectively. While this leaves much to be desired, that the company is now stepping up its efforts and has increased the capex in its business may help.

Though this may keep the company's margins pressured for some time, it would show improvement once the expansion drive gets completed.

For the year-ended December 2010, the company's sales grew by about 11 per cent to Rs 1,160 crore. Profits, however, were marginally down, driven by lower operating margins (down to 18.8 per cent from 21.5 per cent in CY2009). Aventis nonetheless managed to grow its domestic revenues by about 18 per cent. Exports had fallen led by forex fluctuations.

Drastic changes in the government policy on pharma pricing, however, remain a risk.

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