Will Aurobindo Pharma Be Able To Find A Cure For Its U.S. FDA Problems?

Shares of Aurobindo Pharma Ltd. have declined nearly 40 percent so far this year, its worst performance since 2011, on the back of regulatory problems in U.S., its largest market.

The U.S. Food and Drug Administration inspected the company’s various plants this year, issuing adverse observations that may affect production. The Hyderabad-based drugmaker is the second-worst performer on the NSE Nifty Pharma Index, next only to Glenmark Pharmaceuticals Ltd.

Eight of Aurobindo Pharma’s plants were inspected throughout the year.

• Units I and XI have been classified as Official Action Indicated, or objectionable conditions were found, after audit
• Unit XI was recently issued a warning letter—barring fresh approvals.
• The U.S. regulator also issued a Form 483 with Unit VII (seven observations), Unit V (four observations) and Unit VIII (four observations).
• The outcome of the inspection of Unit IV is awaited.

A Form 483 wouldn’t impact existing business, but may impact future approvals if a plant doesn’t comply, impacting future earnings. Aurobindo Pharma, however, said in an exchange filing that none of the observations pertain to data-integrity issues.

The company didn’t respond to emailed queries on their strategy following the U.S. FDA’s actions. This story will be updated once they respond.

Impact Of Inspections

Unit IV will likely be inspected again and approvals may be stuck for at least a year, Anubhav Aggarwal, pharma analyst at Credit Suisse, wrote in a recent report. This unit accounts for 30 percent of the company’s pending abbreviated new drug application—or applications for generic drug approval—which typically have higher margin, he said.

The risk from U.S. FDA will overshadow Aurobindo Pharma’s near-term performance, Chirag Talati, pharma analyst at Kotak Securities, wrote in a recent report, adding that a Corrective And Preventive Action will take six–nine months to be implemented. Talati said given the high number of pending approvals from Unit IV, there’s a risk the agency could likely withhold approvals from the facility unless it’s satisfied with the action’s implementation.

Unit IV, according to Kotak Securities, is expected to account for 15 percent of the drugmaker’s FY20 sales and accounts for the largest number of filings pending approval—47 out of 153. The unit was inspected five times since 2012 and the U.S. FDA has always closed the inspection with a clean chit.

What Can Happen

Regulatory issues threaten to cast a shadow on half of the drugmaker’s pending drug filings.

Emkay Global said that only a positive outcome related to the inspection of Unit IV can help Aurobindo Pharma’s price-to-earnings multiples “going back to its historical range of 12-13x”.

The company said in a post-earnings call for the quarter ended September that it has finished remedial work ordered by the U.S. FDA, including a detailed response on two critical observations for Unit XI. It’s awaiting feedback from the FDA on the classification of inspection for Unit VII. The corrective and preventive actions should be over by FY20, it said, expecting a re-inspection afterwards.

That, according to brokerages, will have a bearing Aurobindo Pharma’s U.S. sales.

The drugmaker’s annual U.S. sales for FY21 and FY22 will decline to low single-digit growth from high double-digit growth presently, according to CLSA. The company’s FY20 U.S. revenue should grow 16 percent year-on-year but may moderate to 3-5 percent as a high base kicks in and plant issues create an overhang, Alok Dalal, pharma analyst at the brokerage, said.

Despite the concerns, the company has maintained growth momentum in the U.S. generic segment on the back of new launches and acquisitions, according to Tushar Manudhane, pharma analyst at Motilal Oswal Financial.

Aurobindo Pharma derives nearly half of its revenue from U.S., followed by the European Union, according to company data.

Impact Of Sandoz Deal

Analysts expect the company’s acquisition of the commercial operations and three manufacturing facilities of Sandoz Inc. in the U.S. to drive revenue growth. While Credit Suisse said completion of the Sandoz deal—costing nearly $900 million—is the “next key catalyst”, Axis Capital said it remains a “rerating driver for the stock”. The company’s core business performance will be supported by value accretion from the Sandoz deal over the next two years, said Neha Manpuria, pharma analyst at JPMorgan.

The company said at the earnings call that it expects U.S. Federal Trade Commission to approve the acquisition in December or January next year.

The deal may also help drive up the drugmaker’s valuations, brokerages said. “Aurobindo Pharma is trading at inexpensive valuations of 6x FY21 EV/EBITDA and 8x FY21 PE, which means the stock is trading at no growth multiples,” Kotak Securities said.

Prashant Nair, pharma analyst at Citi, said the company “continues to outperform peers on growth and margins, courtesy its well-diversified pipeline and superior execution in the U.S.” He expects the performance to sustain but in the near term, the street would focus on compliance outcomes and closure of the Sandoz deal.

Potential For Returns

As many as 29 out of the 36 analysts tracking the stock have a ‘Buy’ rating on the stock, with seven recommending ‘Hold’ and none having ‘Sell’ rating.

The consensus of analyst estimates tracked by Bloomberg shows a target price of Rs 639—implying a 45 percent upside. CIMB is the most bullish on Aurobindo Pharma, with a target price of Rs 950, while IDFC Securities and Philip Capital have targets of Rs 941 and Rs 930. The share is trading below the analysts’ target price.