Aurobindo Pharma Ltd: Business model to strengthen, earnings to soar
We initiate coverage on Aurobindo Pharma (ARBP) with a BUY rating and a
March ’12 target price of Rs 1,260, a 22% upside from current levels. Since the
last few years, ARBP’s business model has undergone a structural shift towards
the high-margin, less volatile formulations segment (10%/55% of sales in
FY05/FY10). We expect this momentum to continue (65% in FY12), infusing
more stability in its business. Moreover, the company’s broad-based portfolio of
product filings has introduced new revenue streams through outsourcing deals
(Pfizer, Astra Zeneca). Licensing income from such deals will shore up cash
flows in the medium term. We expect the company to record a 33% core
earnings CAGR for FY10–FY12E, driven by 16% revenue growth and a 230bps
EBITDA margin expansion. Given the strong growth profile, we believe that the
current valuations, at a PER (core) of 12.1x FY12E, are attractive.
Transforming business towards high-margin, less volatile formulations segment:
ARBP has scaled-up revenue contribution of the formulation segment from just
10% in FY05 to a staggering 55% in FY10. As the structural shift in its business
model continues, this proportion is likely to increase to 65% in FY12E.
Strong product filings create new outsourcing opportunities: APRB, with >1200
filings across international markets (173/819/244 for US/EU/SA), is one of the
world’s largest filers of generic formulations. This has helped it secure
outsourcing deals from Pfizer and Astra Zeneca (Astra). The two deals help ARBP
address both, the developed (Pfizer) and emerging markets (Astra). This enhances
the revenue visibility and reduces volatility of ARBP’s earlier API-driven model.
Licensing income to rev up cash flows: ARBP has received Rs 3.4bn as licensing
income in the last two years — 10x the licensing income accrued in the
preceding five years, thanks to dossier sales and the Pfizer deal. Cash accretion,
to the tune of Rs 3bn, is estimated to continue over the next two years. While we
do not expect this licensing income to continue flowing in the long term, it will
provide a significant fillip to cash flows over the medium-term.
Growth outlook strong, valuations attractive: We estimate ARBP to record a
33% CAGR in its core earnings over FY10-FY12E. The overall growth in the base
business along with strong licensing income will help improve cash flows. The
valuations, at a PER of 12.1x FY12E, factor in balance sheet concerns and are
attractive in view of the company’s growth profile. We have valued ARBP’s core
business at Rs 1,200 (14x FY12E earnings, at a 35% discount to the sector lead
given the partially commoditised API business) and licensing income at Rs 60
(NPV). Our Mar ’12 target price stands at Rs 1,260 (a 22% upside).
Key risks: Regulatory issues (particularly related to USFDA) and delay in product
approvals/launches are the major risks to our call.
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