Regulatory overhang may dent Aurobindo Pharma earnings estimate by 15-20%

Street sentiment regarding Aurobindo Pharma — already weak on account of regulatory observations pertaining to its other facilities — has taken a further hit following the USFDA’s 14 observations to Unit IV, an injectables producing facility. 

The stock, which had almost halved from the Rs 800-level between April and November 13, slumped to its five-year low before closing 8.7 per cent down on Thursday. This was despite the company putting up a decent showing in the September quarter (Q2). 

Analysts say the inspections and observations surprised them, as they were conducted by the USFDA within seven months of the last establishment inspection report (EIR) in April, which had indicated that the facility remains FDA-compliant. 

This has raised further regulatory concerns for Aurobindo, which analysts estimate could knock off as much as a fifth of its earnings. Recently, the FDA had issued four observations each to Aurobindo’s Unit V and Unit VIII — both active pharmaceutical ingredients (API) manufacturing facilities near Hyderabad — after inspections at the end of October. 

These had added to regulatory concerns as Unit VII — the oral formulations unit — had also received seven observations after the FDA’s inspection in September. Though the firm has clarified that none of these observations are related to data integrity issues, the Street’s concerns have intensified. 

Analysts at Kotak Institutional Equities say that with Unit IV and Unit VII (pending Form 483) accounting for 35 per cent of Aurobindo’s US revenues and 80 pending abbreviated new drug applications (ANDAs), the FDA risk will overshadow its near-term performance. A Form 483 is issued by the USFDA if there are conditions that appear to be violating the rules.

Unit IV is Aurobindo’s key sterile facility, and is expected to account for $200 million or 15 per cent of FY20 sales. It has the largest number of filings pending approval at 47 ANDAs (of a total 153 pending ANDAs).

The US remains key, contributing more than half to its consolidated sales in Q2. Total US sales at $404 million (Rs 2,835 crore) grew 27 per cent year-on-year (4.5 per cent sequentially), driving overall revenues for Aurobindo to 18 per cent YoY in Q2. 

Injectables, being complex and facing limited competition, remain significant drivers of US sales and profitability. Hence, it is not surprising that observations for Unit IV have affected sentiment substantially. 

Limited competition in Ertapenem (an antibiotic injection) during Q2 boosted injectables sales by 12 per cent sequentially; injectables as a whole contributed about a fifth to US sales. Aurobindo’s next key market remains Europe. Positively, it contributed about a fourth to overall sales, and grew 21 per cent year-on-year in Q2. In euro terms, growth was higher at 26 per cent. 

The turnaround of acquired firms has driven growth in Europe. Further, the firm continued transferring product manufacturing to India, which has boosted profitability from an operating loss to double-digit operating profit margins.

While analysts remain positive on Europe driving Aurobindo’s prospects, they also feel the acquisition of Sandoz US’ portfolio, once complete, will be key to US sales. 

However, even as Aurobindo’s stock trades at relatively inexpensive valuations of 6x its FY21 enterprise value/Ebitda, and 8x its FY21 earnings, the cautious sentiment is unlikely to change soon. 

This is because, if issues related to Unit IV and unit VII get escalated, it could hurt sales, with potential impact of 15-20 per cent on earnings, say analysts.

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