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Aurobindo Pharma (ARBN.BO)
Financial Impact Priced In; Valuation Overhang May Persist
Cut TP to Rs285; Maintain Buy — We believe that the 20% drop in the stock
over the last two days prices in the financial impact of the import alert on Unit VI. It
could however continue to weigh on valuations till we get more clarity on the
nature of the issues raised by the FDA & potential timeline/cost of resolution. We
remain positive on the operating leverage story, even as we cut FY11-13 earnings
estimates by 3-8% & TP to Rs285 to factor in the import alert.
Import alert on Unit VI — The US FDA has placed ARBN’s cephalosporins facility
(Unit VI) under an import alert, following deviations observed during an inspection
in Dec’10. This stops ARBN from shipping products manufactured at this facility to
the US & could be a precursor to a warning letter. There are two blocks (oral &
sterile) in this unit & ARBN has asked the FDA to clarify whether the alert applies
to both or just the sterile block (most deviations related to this block).
Financial implications — ARBN generates US sales of cUS$35m (c4% of sales)
from Unit VI (oral: cUS$32m; sterile: cUS$3m). Unless the import alert applies only
to the sterile block (unlikely in our view), this is at risk. No ANDAs are likely to be
approved from this unit either (c10-15 pending approval). We believe that even if
the issue is resolved, regaining market share may not be easy as the market
would have moved on. ARBN is also likely to incur some cost on rectifying these
issues. We have incorporated these into our earnings estimates.
Will this spill over to other plants? — We think it is unlikely. We have seen with
other firms (Sun, Lupin) that have had such issues that FDA actions are plant
specific, unless there are repeated deviations across multiple plants. In fact, the
FDA inspected ARBN’s API plant (Unit I) in Jan ‘11 & cleared it without any 483s.
Overhang may persist — ARBN is confident of completing remedial issues within
3-4m (could take longer for the FDA to validate the same) & also indicated that its
deals with Pfizer & Astra are unaffected. However, we expect the issue to weigh on
valuations till we see tangible signs of the same or the issue is resolved.
Lowering Estimates and Target Price (TP)
We lower our earnings estimates for FY11/12/13 by 3%, 8% & 8% respectively to factor in the
potential impact of the Import Alert placed on Unit-VI.
We lower revenues by 3%, 5% & 4% respectively, as we take out all sales to
the US from Unit VI. We believe it is prudent to assume that the import alert
will continue to be on the entire unit (and not just steriles) at this stage. Also,
while ARBN may resolve the issues at the plant, regaining market share in
these products is likely to take time.
Our EBIDTA estimates are lower by 3%, 7% & 7% respectively. We assume
gross margins of c50% on the affected sales - this flows down to PBT. We
also build in additional cost for the remedial action that the company will
have to take.
This translates into our FY11/FY12/FY13 FDEPS estimates being lower by
3%, 8%, 8% respectively.
We maintain our positive stance on the stock and strongly believe in the
operating leverage story. We maintain Buy, Medium Risk (1M) rating, but cut
our TP to Rs285/share (Rs326/share earlier).
Aurobindo Pharma
Valuation
We value Aurobindo using a sum of the parts approach. Given that pharma is a
growth sector, we use P/E as our primary method to value the base business of
pharma companies. We value Aurobindo’s core earnings on 14x 12m forward
FDEPS - a 30% discount to the target multiple of 20x that we use for sector
leaders such as Cipla and DRL. We believe that the discount is justified at this
point, given the possibility of equity dilution (to redeem FCCBs in case they do
not get converted), risk of an appreciating rupee (c20-25% net exposure) and
higher customer concentration (the Pfizer deal). At 14x Mar ‘12E EPS we value
Aurobindo’s core business at Rs265/sh. We also value Aurobindo’s dossier
licensing income at 5x. We believe the lower multiple captures the fact that this
income stream may not be recurring, at current levels, over the longer term. At
5x Mar'12 estimates, we value Aurobindo’s dossier licensing income at
Rs20/sh. Cumulatively, we arrive at our target price of Rs285/sh.
Risks
We rate Aurobindo Medium Risk as opposed to the Low Risk assigned by our
quantitative risk-rating system, which tracks 260-day historical share price
volatility. We maintain Medium Risk as the recent run-up in the stock and
convertible bonds maturing in May 2011 could prove to be a technical overhang
if the stock continues to rise. Key downside risks that could impede the stock
from reaching our target price include (1) Fresh equity dilution if FCCBs do not
get converted; (2) Execution hiccups in the supply deal with Pfizer; (3) Currency
Risk - an appreciating INR would be structurally negative.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Aurobindo Pharma (ARBN.BO)
Financial Impact Priced In; Valuation Overhang May Persist
Cut TP to Rs285; Maintain Buy — We believe that the 20% drop in the stock
over the last two days prices in the financial impact of the import alert on Unit VI. It
could however continue to weigh on valuations till we get more clarity on the
nature of the issues raised by the FDA & potential timeline/cost of resolution. We
remain positive on the operating leverage story, even as we cut FY11-13 earnings
estimates by 3-8% & TP to Rs285 to factor in the import alert.
Import alert on Unit VI — The US FDA has placed ARBN’s cephalosporins facility
(Unit VI) under an import alert, following deviations observed during an inspection
in Dec’10. This stops ARBN from shipping products manufactured at this facility to
the US & could be a precursor to a warning letter. There are two blocks (oral &
sterile) in this unit & ARBN has asked the FDA to clarify whether the alert applies
to both or just the sterile block (most deviations related to this block).
Financial implications — ARBN generates US sales of cUS$35m (c4% of sales)
from Unit VI (oral: cUS$32m; sterile: cUS$3m). Unless the import alert applies only
to the sterile block (unlikely in our view), this is at risk. No ANDAs are likely to be
approved from this unit either (c10-15 pending approval). We believe that even if
the issue is resolved, regaining market share may not be easy as the market
would have moved on. ARBN is also likely to incur some cost on rectifying these
issues. We have incorporated these into our earnings estimates.
Will this spill over to other plants? — We think it is unlikely. We have seen with
other firms (Sun, Lupin) that have had such issues that FDA actions are plant
specific, unless there are repeated deviations across multiple plants. In fact, the
FDA inspected ARBN’s API plant (Unit I) in Jan ‘11 & cleared it without any 483s.
Overhang may persist — ARBN is confident of completing remedial issues within
3-4m (could take longer for the FDA to validate the same) & also indicated that its
deals with Pfizer & Astra are unaffected. However, we expect the issue to weigh on
valuations till we see tangible signs of the same or the issue is resolved.
Lowering Estimates and Target Price (TP)
We lower our earnings estimates for FY11/12/13 by 3%, 8% & 8% respectively to factor in the
potential impact of the Import Alert placed on Unit-VI.
We lower revenues by 3%, 5% & 4% respectively, as we take out all sales to
the US from Unit VI. We believe it is prudent to assume that the import alert
will continue to be on the entire unit (and not just steriles) at this stage. Also,
while ARBN may resolve the issues at the plant, regaining market share in
these products is likely to take time.
Our EBIDTA estimates are lower by 3%, 7% & 7% respectively. We assume
gross margins of c50% on the affected sales - this flows down to PBT. We
also build in additional cost for the remedial action that the company will
have to take.
This translates into our FY11/FY12/FY13 FDEPS estimates being lower by
3%, 8%, 8% respectively.
We maintain our positive stance on the stock and strongly believe in the
operating leverage story. We maintain Buy, Medium Risk (1M) rating, but cut
our TP to Rs285/share (Rs326/share earlier).
Aurobindo Pharma
Valuation
We value Aurobindo using a sum of the parts approach. Given that pharma is a
growth sector, we use P/E as our primary method to value the base business of
pharma companies. We value Aurobindo’s core earnings on 14x 12m forward
FDEPS - a 30% discount to the target multiple of 20x that we use for sector
leaders such as Cipla and DRL. We believe that the discount is justified at this
point, given the possibility of equity dilution (to redeem FCCBs in case they do
not get converted), risk of an appreciating rupee (c20-25% net exposure) and
higher customer concentration (the Pfizer deal). At 14x Mar ‘12E EPS we value
Aurobindo’s core business at Rs265/sh. We also value Aurobindo’s dossier
licensing income at 5x. We believe the lower multiple captures the fact that this
income stream may not be recurring, at current levels, over the longer term. At
5x Mar'12 estimates, we value Aurobindo’s dossier licensing income at
Rs20/sh. Cumulatively, we arrive at our target price of Rs285/sh.
Risks
We rate Aurobindo Medium Risk as opposed to the Low Risk assigned by our
quantitative risk-rating system, which tracks 260-day historical share price
volatility. We maintain Medium Risk as the recent run-up in the stock and
convertible bonds maturing in May 2011 could prove to be a technical overhang
if the stock continues to rise. Key downside risks that could impede the stock
from reaching our target price include (1) Fresh equity dilution if FCCBs do not
get converted; (2) Execution hiccups in the supply deal with Pfizer; (3) Currency
Risk - an appreciating INR would be structurally negative.
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