Stock Review: Aurobindo Pharma

Focus on formulations, in addition to an alliance with leading multinational Pfizer, aided profitability

It could just be the right prescription for Aurobindo Pharmaceuticals — a shift from the commodity-based businesses to a more value added product portfolio, reduction of debt and an alliance with a leading multinational. In 2008, the company was hit by low earnings visibility, a leveraged balance sheet and concerns over conversion of foreign currency convertible bonds. But, the company has now changed its product portfolio to formulations rather than active pharmaceutical ingredients (chemicals used in manufacturing drugs).

The formulations business now commands 54 per cent of revenues compared to 10 per cent a few years ago. Building of a strong product portfolio (oral contraceptives, controlled substances and injectibles and branded generics) has seen its earnings before interest, tax, depreciation and amortisation margins grow 173 basis points to 20.3 per cent. The contribution from the segment is expected to grow to 63 per cent by the next financial year, reckon analysts. The company has managed to shape up its balance sheet, with leverage moving into the rational zone. From 1.9 times, the debt-to-equity ratio has come down to 1.2 times. Operational cash flows will ensure that the number comes down to 0.7 times in FY12, say analysts. Operational matrices have not been impressive, as operating profit margins contracted 4.3 per cent during the June quarter due to rising staff costs and other expenditure. The management attributes this increase in expense to operationalisation of two large formulations manufacturing facilities. Net earnings also fell 69 per cent year-on-year during the quarter.

The focus on formulations has led into an alliance with Pfizer to supply over 100 products in both regulated and emerging markets. This could enable the company ramp up sales and margins. From a valuation perspective, analysts reckon that the company is trading at a discount to the broad market and to the sector (around 45 per cent). However, strong restructuring medicine and clarity on the earnings front may turn the game.