High margin, growth prescription for Strides Arcolab

Ascent sale will help raise funds for deleveraging its balance sheet and invest in fast growing specialty injectibles business

It is not surprising that Strides Arcolab’s stock has risen sharply after the company announced the sale of its stake in the low-margin subsidiary, Ascent Pharma. Post this news or in just five trading sessions, the stock is up 29 per cent to Rs 526 currently—its all-time high. The all cash deal involves Strides selling its 94 per cent stake in the subsidiary to Watson Pharma at an enterprise value of US $393 million. Strides, which will garner $370 million for its stake, will thus be able to drastically cut its gross debt of close to Rs 2,625 crore and save on interest costs. On the other hand, it will still have cash to fund expansions in its fast growing core specialty business comprising of sterile products (presently around 44 per cent of its portfolio). The absence of low margin generics business will also mean that overall margins of the company will improve by around 500 basis points, say analysts. One percentage point is 100 basis points.

In this backdrop and even after the recent rise, most analysts remain positive on the stock. Though consensus target price for the stock stood at Rs 522.71, post the deal announcement analysts are raising their target price. For instance, analysts at Macquarie have raised their target price to Rs 625.

Sale at attractive valuations

Strides was on a lookout for some time to unlock value out of its low margin subsidiary, Ascent Pharma which markets products in Australia and Southeast Asia. Its portfolio comprised of close to 400 products including generics, over-the counter selling (OTC) and skincare range. In Australia, Ascent focussed on promoting its dermatology product range through a specialist sales force to dermatologists, doctors and pharmacists for treating mild to severe skin conditions. However, overall it had a total sales force of 300 people promoting various products in around eight countries. This entire sales force along with the Ascent’s manufacturing facility at Singapore will now go to Watson.

While CY11 results are yet to be declared, analysts at ICICI Direct in their report estimate Ascent to clock sales of close to $154 million with EBIDTA of around $19 million. On the basis of these, it translates into a deal valuation of around 2.5 times sales and around 20 times EV/EBIDTA, which is a lucrative price and good bargain for Strides.

Boost to profitability

Likewise, based on these estimates, the EBIDTA margins work out 12.33 per cent. These low margins have been a drag on overall margins given that the company had clocked in EBIDTA margins of nearly 19 per cent in CY2010—even for CY2011, the consensus estimates stand at 20.8 per cent. Thus, though the sale of Ascent may lead to a decline in overall revenues in the immediate term, it will push up overall margins. As per revised analysts’ estimates, Strides’ EBIDTA margins may touch 26 per cent in CY2012.

That apart, Strides will also benefit from lower interest costs as it plans to utilise $250 million of the sale proceeds towards reducing its debt. Total debt (including FCCB’s) on its books stands at $525 million, as per analysts at Reliance Securities, translating into debt-equity ratio of 1.6 times. Post the loan repayment, its debt will come down to $275 million and the debt-equity ratio to a reasonable level of 1.0.

Other growth drivers in place

Even after the stake sale in Ascent, Strides will continue marketing Pfizer’s established off-patent medicines and branded generics in Australia through direct distribution channel, observe analysts at Reliance Securities in their report.

That apart, Strides has two major licensing agreements with GlaxoSmithKline and Pfizer, which continue to contribute to its growth. Glaxo sources products from Strides for emerging markets while Pfizer is commercialising off-patent products, primarily injectibles licensed/supplied by Strides for regulated markets like US. Backed by Pfizer’s strong marketing, distribution and low competition, analysts at Motilal Oswal Securities observe that Strides targets 15-25 per cent market share in the US. Analysts at Macquire in their report observed that contracts are structured using a pick-or-pay mechanism, guaranteeing minimum revenues to Strides and a share in end-profits.

More importantly, Strides will continue its focus on branded generics business in India and Africa as well as its focus on institutional sales related to anti-malarial and anti-TB segments. However, the key focus area still remains the specialty segment business (recently renamed as Agila), which mainly comprises sterile products and post Ascent is estimated to account for over 60 per cent of Strides’ revenues.

Strides has an impressive product pipeline to aid future growth in the specialty segment. It has commercialised its first oncology approval in US i.e. gemcitabine, which also has a significant market ($700 million). Analysts at MSFL estimate sales of close to $10.5 million for Strides from this product in CY2012.