Aurobindo Pharma Limited
Summary:
We are at the helm of witnessing an exciting quarter at Aurobindo
Pharma. The company reported flat revenue in the last quarter but with the
approval of Abilify, Namenda in the current quarter and fast movement in the
products, which got approved in the latter half of the last quarter, we expect
the sales to grow at 20% over Q2 FY 2015-16. Aripiprazole's (drug name of
ability) patent got over in April and companies who got the initial approval
saw their revenues grow at an exorbitant rate. Aurobindo pharma has a lot of
competition to fight against in order to gain a good share of the $7.3B market.
We can't expect anything similar like Cymbalta in this case. The company has
also got the approval to sell generic version of Namenda in October. The
estimated market size of the same is $1.23B. We believe that the company's
sales will also increase with the help of increase in sales of Rolaxifene,
Entecavir and Omeprazole (Drugs for which company got approval in the latter
half of the last quarter) whose combined market size is $1.22B. Generic pharma
sector has a bright next year, as many top selling drugs will lose their
patents in 2016. The estimated size of those drugs is worth $20-25B.
India has become a very major player in the generic market. The
generic market in India is on the route to become a $50B market. Over the past,
Indian companies receive most of the first generic approvals. Taking an example
of Abilify, out of the 4 companies that got approval to produce Aripiprazole’s
generic medicine, 3 were Indians (Torrent, Alembic and Hetero) and 1 was from
Israel (Teva). The stocks of all Pharma companies have risen multifold but only
few will sustain and others will wither.
According to us, the price per share of Aurobindo Pharma should be
in the Rs.600-650 range but is currently trading at 34% premium i.e. at Rs.834.
We believe that 34% premium is high for Aurobindo because of the reasons
presented in the report. Compared Relatively, the company is valued a bit lesser than its peers but
with better products approval, better acquisitions functioning, lower debt,
stable growth performance and high sales to capital ratio, we believe that
company’s relative multiple will move towards or even become better than the
Industry average.
Q2 Numbers:
1) APL reported revenues of Rs. 3362 crores in Q2 up 15.7% YoY and 0.4%
QoQ on account of increase in sales through Cefixime (Suprax).
2) EBITDA margins improved by 5.2% and PAT margins improved by 4.9%
from Q2 2014-15 as Actavis business has started registering small digit profit
than posting losses.
Dissecting the
Business of Aurobindo:
Aurobindo has two main streams in which it does its Business.
1) Formulations.
2) API’s.
API was it’s
main Business initially, but over the last decade they started focusing more on
the Formulations segment and now formulations account for 80% of it’s revenue while API contributes the rest.
FORMULATIONS:
Analysis of
Revenue from Formulations and where is that headed:
Formulations
generate its revenue from 4 major sources:
1) US Sales
2) Europe Sales
3) RoW
4) ARV’s
Past,
Present and Future of each of these sources:
1) US Sales:
The US business, which constitutes a major part of the revenue of company, has 5 main channels of generating revenue.
1) Aurobindo US,
2) Auro Life,
3) Auro Medics,
4) Auro Health and the newly acquired
5) Natrol.
Aurobindo US was able to
generate revenue of near around $500m in 2014-15. Aurobindo US mainly generates its revenue from Oral Solids. In the current year, Aurobindo US posted
average growth with sales increasing because of approval of Cefixime (Suprax). The US Business grew by 6.6% in Q1 and 3.3% in Q2 on QoQ basis. This has made us question the base growth in the Auro US business. The whole
growth depends on the new approvals received from the FDA and if the product
market size isn't good enough, the numbers remain on a flattish note. The
company has also filed para IV in respect of many products. If they are
successfully able to invalidate a patented product, we can see good growth in
the revenue numbers in the future. The company got approval to sell Aripiprazole and Namenda in the current quarter and Rolaxifene, Entecavir and Omeprazole in the ast quarter. We expect to see US sales increasing by 20-25% because of these approvals.
Aurolife is in the
business of manufacturing controlled substance and fulfilling government
orders. Government orders amounted to $35m in 2014-15. The contract received
was for a period of 5 years. The company has been planning to raise the contribution of Controlled Substance in its revenue as the margins in this segment are better than what the company gets through sale of other generic products.
Auromedics is in the
business of injectable products. The company is planning to enter in the
Injectable segment in a big way and intends to make it as it’s biggest source
of revenue. The company is in the process of filing products with a market size
of $3B. The company expects to file the same by beginning of 2017. The products
are very complex and require a lot of research. The company has been spending
heavily in the Injectable Segment. It is not vertically integrated in
Injectable as it is in its oral products. The company received 11 ANDA
approvals in the injectable segment this year increasing the number of
approvals from 6 to 17. The approved and manufactured products do not have a
large market size and that is the reason we have not seen a huge growth in the
revenue numbers. The growth in US numbers this year has come due to approval
received for selling Cefixime,drug name for Suprax. The product has done well
for Aurobindo while allowing better margins. Auro Medics business in 2014-15
was around $67m and with Meropenem, angiomax and other products, we expect that
to increase to $75-80m.
Aurohealth manufactures
and sells OTC products. It is a new avenue for the company and through proper
retail distribution channel the company expects to increase its US revenues.
Natrol is into the
business of Neutraceutical’s and has revenue of around $110m a year. Natrol
posted revenue of $31m from Dec 4, 2014 to March 31, 2015. We expect the margins to improve going forward with efficiency coming in. We calculate a CAGR of 15% over 2015-2018E.
Aurobindo acquired
Natrol for $132m and posted goodwill of around Rs.465.6 crs.
Aurobindo filed a complaint against Natrol after learning
discrepancies in the value of acquired assets under the asset purchase
agreement. Aurobindo even might have to
assume certain disputed liabilities of Natrol. Clearly, Aurobindo didn't
acquire Natrol with proper due diligence. The company might have to face
material loses in the future in this respect and the acquisition cost might
increase from $132m. Goodwill and brands were not amortized in 2014-15. We
might see reduction in EBIT levels in the future.
The company has tied up with Citron Pharma to distribute its product
in the market and is paid distribution margins. Aurobindo hasn’t disclosed the
margins, which are paid to Citron.
The company also has a Joint venture with Celon labs for the
manufacturing of Hormones and Oncology Products in the USA. Aurobindo’s share
in the Joint Venture is 60% while the rest is with Celon Labs.
The spurt of 12% growth in the below chart is because of the
addition of Natrol’s revenue. Growth in 1st Quarter is mainly
because of Cefixime (Suprax). US Sales otherwise shows a normal growth. We
expect the sales to increase by 20% in Q3 to Rs.1773 Crs.
2) Europe Sales:
Aurobindo
acquired Actavis’s Western Europe Business and started posting revenues from
April 1, 2014. Actavis has helped Aurobindo to increase its presence in 7 countries
of Western Europe. Through the acquisition of Arrow Generiques, Aurobindo is
planning to increase its presence in France in a major way. Actavis had sales of around $320m in 2014-15.
We can’t compare Europe Business before and after 2014 but the revenue after
Actavis’s acquisition is hovering in the $125-130m range per quarter.
The company had made it pretty clear that they are focusing on
improving the margins rather than increasing the sales. We are expecting
Aurobindo to post single digit margins from Actavis’s Business. We expect sales to grow from next year at a CAGR of 8% over 2015-2018E.
Actavis held
their Western Europe business for sale after their management decided to focus
more on Central and other parts of Europe. Aurobindo acquired the assets and
posted a capital reserve of Rs.78.75 crs. Actavis was losing 23m on
EBITDA, which Aurobindo was able to bring down to 10m in 2014-15 and posted a
small single digit EBITDA profit after 18 months of acquisition.
Actavis's gross receivables and potential uncollectible debtors
amounted to $57.6m and $8.7m included firms and government of Italy, Spain,
Portugal and Greece. Actavis didn't write off any amount of this and therefore
Aurobindo might have to write off some of this in the future. If we are able to
bring the Actavis business PAT neutral by year-end, we believe we made a sound
deal by acquiring the loss making business of Actavis.
The company is in the process of moving products from Europe to
India. They have already brought 3 products. The company is in the process of
raising $600m required for complex filing and registrations needed to shift
from Europe to India.
3) RoW:
The RoW market contributes around 5% of the revenue share for
Aurobindo. RoW mainly includes countries like Brazil, Canada, South Africa,
Mexico and others. RoW market used to float in the $18-21m range till 2014-15
but with new orders predominantly from Brazil and South Africa, it has started
to hover in the $25-26m range. We expect it to post a CAGR of 10% over 2015-2018E.
4) ARV Business:
ARV (Anti-retroviral) Business constitutes of selling Drugs and
Medicines for HIV/AIDS. The Business saw a major shift when they started
executing notable tenders and the revenues doubled to around $51m in the Q3
2014-15 over Q2 2014-15. The tender received was for 2-3 quarters only but with
huge demand and production capacity for these drugs, we expect the ARV Business
to post a CAGR of 10% over 2015-2018E.
API’s:
API Business constitutes of 3 major components namely SSP (Semi-Synthetic
Penicillin), Cephalosporins and Non-Beta Lactam products.
Aurobindo was started as a SSP selling company and now SSP
constitutes only 5-6% of its overall revenue. SSP constitutes around 30%,
Cephasplorins constitutes around 35% and Non-Betalactam constitutes around 35%
of the API Business. Revenue of the API business ranges in between $100-110m. The
API business of the company has almost remained stagnant but because of large
demand of API's the company has expanded facility in its Unit XI. The expanded
Unit will start generating revenue from the latter half of 2015-16 and
therefore increase in API's revenue is expected in the coming quarter. The main
reason of API business not expanding earlier was because of the In-house needs
of the company. We expect a CAGR of 5% over 2015-2018E.
Total Sales:
Apart from Formulations and API’s, Aurobindo Pharma also generates
revenue through sale of Dossiers. The revenue through sale of Dossiers is very
small compared to over all revenue. As discussed above, sales of the company
increased by 50% because of acquisition of Actavis’s Western Europe’s 7
countries and Natrol. We have assumed revenues to grow by 17% till 2018E and then gradually come down to 10% by 2025E. Our estimation of 17% is in line
with Management’s expectation of $3B sales in 2017-18. With a lot of drugs getting expired next year, we believe that if the company is able to get first time generic approval for a top selling drug, we
might see very good growth in numbers. The premise for high sales can’t be
speculated and we will have to wait for those approvals to be given.
Important
points to keep in mind while Valuing Aurobindo:
1)
R&D at Aurobindo:
The company is in the process of filing for Complex Injectable
products worth $3B in 2017. Aurobindo has spent good amount for its R&D and
infrastructure and we believe with those getting approved, we see a shift
towards Injectable as Aurobindo’s main revenue segment.
As Aurobindo did not produce much complex products, R&D spend
was not as higher as it would be in the Future. The company has also not
invested in Biosimilars, NCE’s and NDDS.
Going ahead we see that the company will invest heavily in its
R&D segment, as that is where the growth will come from.
Eg: Cadila received approval for manufacturing of Biosimilar of
Adalimumab, currently World’s highest selling drug. This has helped Cadila
generate a good amount of revenue.
2) Player in a Competitive Market:
Aurobindo has a good Vertical integration benefit and has been
executing brilliantly in the US markets through its distributing partners and
this might be one of the reasons that it has been able to generate revenue in
this competitive intense market. Most of the generic drug it is getting
approval for, already has players manufacturing it. Even in the case of
Cymbalta where the company got first time generic approval, there were many
other players who received the approval but with strong Vertical Integration it
was able to achieve a near around market share of 25%.
3) Governance Issues:
Aurobindo in our belief passes through some grave Governance issues.
The company declared an Undisclosed Income of Rs.300mn after an Income Tax Raid
happened on its premises in February 2012. The company did not change its
Auditors post the declaration of Undisclosed Income. This poses serious
questions on the Management as to whether the Auditor was at fault or the
Management.
There have been many instances of Insider trading in the company.
Selling before issues related to US FDA structures given against an Injectable
facility became public and Buying when the issues were gradually getting
resolved.
The company has not given explanation to many things presented in the
Annual report. The management has not provided any details in respect of Loans
and advances given in cash or kind. Others in Other liabilities have increased
from 161 crs to 624 crs in the last year. We expect the management to provide
explanation for the same but there was none provided.
4) Working Capital Days
The Working Capital days of the company has been in the range of 140
days, which is high compared to its peers. As being a generic player only,
Aurobindo doesn’t command greater negotiating power with its buyers. It has
also been not able to efficiently utilize its Inventory. The Inventory turnover
ratio is also lower compared to other peers. Going forward with better complex
products we expect it to come down to 130 days.
5) Low Sales to Capital Ratio:
Company’s Sales to Capital ratio has been a worrying sign. It has
grown over the last 3-4 years from 0.94 to around 1.1 (without accounting for
Actavis’s sales) but still is too less given the premium at which it is valued.
We expect sales to improve without much infusion of capital in the future. We
expect it to grow to 1.35-1.5 going ahead.
Final
Comments:
Q3 is critically important for Aurobindo as
they will have to post growth in every segment of the company.
1) Aurobindo US division is
expected to grow by 20-25% over the last quarter with sales expected from
Aripiprazole, Namenda, Rolaxifene, Entecavir and Omeprazole.
2) AuroMedics is
expected to grow to $75-80m.
3) Europe business expected to show good EBITDA level
profits.
4) API business to grow from expanded Unit XI facility.
The sales to capital ratio of the company is
improving but there is a still a lot of improvement left. The company is
investing heavily in the injectable business and good growth is expected from
that business post 2017. The company is also installing one more line in Natrol
that will help them in better capacity utilization. Future sales will increase
without much expenditure in the Natrol Business. The company is in the process
of raising $600m of which $350m will be needed for API expansion, finished dosage
expansion for moving products from Europe to India, complex filing and
registrations needed for filing to shift from Europe to India. With most the company’s revenue coming from
US and with forecast suggesting rupee to depreciate further, we expect a good
increase in its revenue and rise in forex losses because of restructuring of
debt.
The value per share we arrived at is Rs.600-650
and the market price per share is trading at 34% premium at Rs.834. We valued
the company using DCF analysis. With margins expected to come from Actavis and
good launches to come in the following quarters and year, we have assumed
EBITDA levels to grow from 23% to 27% and then gradually come down to 21% by
2025 because of pricing and market share erosions. We have taken the
discounting factor at 14% with 1% added because of the Governance issues. We
have taken the terminal growth at 5%.
We believe the premium is high because of the
following reasons:
1) Highly Competitive Market.
2) Lack of R&D.
3) Return of Formidable players from the FDA
bans.
4) Governance Issues.
5) Low Sales to Capital ratio.
6) High Working capital days.
7) Lack of growth in the recent quarters.
Our projection is aligned with the views of
management i.e. reach $3b by 2017-18. The premium is mostly based on the belief
of the company getting a first generic approval of a high selling product like
Cymbalta.
The companies base business is not growing at an
expected level. Company’s debt currently stands at $662m, which is expected to
increase with $600m the company is planning to raise.
The company is supposed to have inspection in its manufacturing
facilities. If the FDA finds flaws in the manufacturing facilities, it can have
serious impact on the sales and valuation of the company. The company has replied
to the queries raised on the earlier two inspections done by the FDA and is
positive that the issue will be resolved in favor of Aurobindo.
We would like to wait and see how Q3 unfolds and then re-value the
stock. The stock might rally upwards only on positive news. The stock is valued
cheap on relative valuation but with better products approval, better
acquisitions functioning, lower debt, stable growth performance and high sales
to capital ratio in the future, we believe that company’s relative multiple
will also move towards or even become better than the Industry average.
