Strong growth outlook for Aurobindo Pharma after Q4 slip

Large US portfolio, lower price erosion expected to drive earnings

Aurobindo Pharma's lower than expected March quarter performance weighed on the sentiment as the stock corrected almost 7.5 per cent intra-day before closing 4.23 per cent down at ~579.5. Pricing pressure in the US, led by increasing competition and channel consolidation, product recalls, and plant remediation costs affected its performance. The US formulations business (43 per cent of revenues) grew only 5.8 per cent year-on-year (y-o-y), compared to 9.4 per cent in the third quarter. The company's Unit IV had received nine observations in February from the US drug regulator after inspections. Since the unit caters to injectables and ophthalmic products, both high margin products, there was some effect. It was not surprising that operating profit margins declined 390 basis points sequentially to 19.9 per cent.

Nevertheless, the good news is that the management said it had received an establishment inspection report (EIR) for Unit IV, which marks the end of inspections. While a major concern about escalation of issues seems to have been addressed, growth is likely to follow suit with product approvals and supplies ramping up. Ranvir Singh, analyst at Systematix Shares, said the impact of recent product recalls in the US and delays in launches of anti-retroviral products might be seen in the June quarter performance too, with a gradual uptick following thereafter. Injectables, being difficult to manufacture, face limited competition and bring in close to a fifth of Aurobindo's US sales. Despite the pricing pressure, the company is witnessing single-digit US sales growth, compared to declines seen by many larger peers. Further, its strong US product pipeline (about 117 pending approvals) and 11 new products, including two injectables in the fourth quarter of 2017-18, are expected to drive growth.

Notably the company's European business (more than a fourth of sales) is aiding growth as this segment reported 48.2 per cent y-o-y growth in the March quarter. Analysts say even adjusting for acquisitions, the company's base business growth of 15 per cent is impressive and it may be exploring more inorganic European opportunities. The transfer of 83 products from Europe to India for manufacturing is positive from a margin point of view. 

Overall, analysts feel that the beaten-down valuations offer an opportunity. The company is trading at 12-14 times its 2018-19 estimated earnings, compared to Sun and Lupin's 18-25 times.