Aurobindo Pharma

Investors with a long-term perspective can consider taking exposure in the stock of Aurobindo Pharma, a leading API and formulations manufacturer. Our recommendation stems from the company's improving sales mix and margins, improving cash flows and long-term revenue visibility from its supply agreement with Pfizer Inc.

What also underscores our optimism is the company's expanding presence in the export market and the fast-growing chronic therapy segments. At the current market price of Rs 916, the stock trades at about 10 times its likely FY-10 per share earnings. However, since the stock price has run up significantly in the last couple of months, returns from hereon may only be moderate.

Improving mix and margins

Traditionally a strong player in semi-synthetic penicillins (SSP) and cephalosporins, Aurobindo has over the years built up its strength in the formulations business too. From just about 11 per cent in FY05, the formulations business has scaled up its revenue contribution to more than half the sales revenue pie.

With manufacturing capacities in place, having invested close to Rs 1,000 crore in setting up infrastructure, the management expects the contributions of formulation to total sales to go up to more than 80 per cent in the next four-five years.

Though this may appear a tad too ambitious, it may not be unachievable given the company's historic growth rates and increasing focus of high-margin products in regulated markets. The supply agreement drafted earlier with Pfizer Inc will also fuel the growth in formulation business. The improving product mix in favour of formulations will also help the company etch a better margin picture as formulations enjoy higher margins than active pharmaceutical ingredients. Margins may also get a lift from better utilisation of its capacities.

For almost half a decade, Aurobindo had undertaken a massive expansion in capacities; with that in place now, the company may be able to improve its capacity utilisation. Here again, the long-term Pfizer supply agreement would help the company better utilise its assets.

Pfizer deal, a winner

Earlier last year, Aurobindo had entered into an in-licensing and supply agreement with Pfizer Inc to supply solid dosages and sterile products. Pfizer had acquired the rights to 39 generic solid oral dose products in the US and 20 in Europe, plus 11 in France.

The ambit was later expanded to include 55 solid oral dose products and five sterile injectable products for several countries throughout Asia, Latin America, Africa and West Asia. Apart from providing a long-term revenue stream for Aurobindo, the deal would also help improve its cash flows given the licensing and milestone-based inflows involved. While the revenue contribution from the deal is still not very significant, given Pfizer's marketing reach and the growing acceptance of generics worldwide it can scale up to more than 20 per cent levels in the coming four-five years.

Results

The company's consolidated sales for the three months ended Sept-09 grew by 24.6 per cent over the year. The formulations business remained the lead revenue generator, making up over 49 per cent of gross sales, helped by a strong growth in the US market with new product approvals and gains in market share. APIs made up over 49 per cent, with the rest coming from the company's dossier income.

The company also improved its operating margins by over 320 basis points to 19.8 per cent (net of dossier income). In terms of product approvals, the company continued to spread it wings across markets.

In the US itself, the quarter saw the company receive 10 approvals. It currently has a total of 110 ANDA approvals (82 final approvals and 28 tentative approvals) from the USFDA. On the whole, it posted a consolidated net profit of Rs 103 crore as against the loss of Rs 38.5 crore incurred in the corresponding quarter last year (due to forex losses).

FCCB trigger

The company's cumulative $154 million outstanding FCCBs may hold the trigger to further upside. Given the improving financials and current market price, while the first tranche ($39 million due for conversion at Rs 522) may, likely, get converted into equity, the remaining debt, convertible in two tranches in May 2011 at Rs 879.1 ($33 million) and Rs 1014.1 ($106.2 million) could pose some challenge.

Here again, while the $33 million debt has a high probability of getting converted, the bonds convertible at Rs 1,014.1 could come up for redemption. While the company is not exactly cash-rich now, the accruals from the Pfizer deal could help it create a cash bank towards such an eventuality. Even so, if forced to tap other financing options to partly fund the redemptions (if any), Aurobindo may not have a problem, given its improving balance-sheet.

via BL