AstraZenca - Have they learnt the right lessons?

Lessons from Mr Market
1

Please go through this moneylife article to geta brief onthe recent past of the company.

http://www.moneylife.in/article/the-deadly-delisting-itch-of-astrazeneca-pharma-india/29731.html

Would encourage you to read the complete article to get a sense what they are up to.

Still, if i could summarize the whole thing in just a few sentences that would be, promoters have been bullish on the India story since some time (going by their delisting attempt,open offers and open market purchases to hike their holding from 56.51% in 2001 to90% now), business was doing reasonably well between 2008-11 with RoE/RoCE well above 35% and net margins in 15%+ range, dividend payout ratio in range of 40% (referring to data on screener.in), until they decided to play the ā€œinnocent gameā€ of suspending production, recalling their sterile products manufactured in Bā€™lore and reporting reduced sales and losses in the last 4 quarters with a intention (probable) to delist at the lowest price possible.

**Cut to present **

1). The company has announced "We have now restarted production and are in the process of restoring affected products to the market in a phased manner. We will continue to work hard to resume supply for those medicines which remain out of stock.

You have our commitment that quality will always be our first priority, therefore we will only reintroduce products when we can assure that our global quality standards are met."

http://www.astrazenecaindia.com/msgtocust/

2). Delisting game is off -http://www.financialexpress.com/news/astrazeneca-pharma-india-to-cut-promoter-holding-not-delist/1084218/1

3). Today, the company has reported that,

)- Commencing operation at new tablet facility.

)- Retrieving market share of the company products, supplies of which were interrupted last year.

)- Further strengthening the brand presence, Enhancing sales force effectiveness, improved cost management.

)- Promoters AstraZenca Pharma Sweden has decided to provide a voluntary, **non-repayble **financial grant of approax Rs. 114-140 cr. between FY14-16 under a subvention agreement of which the first tranche of 74 cr. will be provided in the current financial year.

http://www.bseindia.com/xml-data/corpfiling/AttachLive/AstraZeneca_Pharma_India_Ltd_060513.pdf

Is there a Investment theory ?

If the above points indicate a change of heart on part of the promoters and they want to get back to business as usual, then we may have a MNC Pharma company capable of havingRoE/RoCE well above 35% , net margins of 15%+ , dividend payout ratio of 40%+, Debt free and growth rate of ~20% ? available at ~21 times FY14 earnings (assuming 600 cr. revenue and ~100 cr NP kind of scenario, if they are able to go back to the ā€˜pre-innocenceā€™ days)

Would love to have comments from all of you.

Disc: Have a starter position and reading up more to see if this is worth following up.

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1 Like
2

I see few risks here.

1). How fast they can recover to their innocent days?

2). Can they make 100cr NP in FY14? - I am doubtful (If 74cr is added than most like possible, but does the 74 cr will add to FY14 earning is my question?)

3). What about the effect of promoter selling their stake, wonā€™t it give us better entry point

3

Having seen AZ projects, I must say AZ is facing one of their toughest times globally. Companies like Lilly have cut down their global sales force by half, these are dire times for big pharma, the rosy days of very high margins and riding on big blockbusters are over. Apart from the ones having a solid pipeline, not all will sail through this time. Time to get really cautious with Big Pharma.

In the Life Science sector, the so-called apatent cliffa that saw blockbuster drugs with aggregate global sales of US$67bn go off-patent in 2012 alone continues to hang over aBig Pharmaa.

http://www.thepharmaletter.com/file/121681/astrazeneca-sales-and-earning-down-in-1st-qtr-2013-as-patent-cliff-bites.html

ā€œAstraZeneca (AZN) is probably the best example of a company facing the dreaded patent cliff. In 2014 the patent expires on Nexium (gastro reflux drug) which was responsible for nearly $5bn of revenue in 2010. Two years later the patent on Crestor, a cholesterol lowering drug, expires and this product generated $6bn of revenue in 2010. These two drugs alone accounted for around 30% of AstraZenecaā€™s entire revenue. Arimidex, whose patent expired in 2011, saw revenues halve the following year, and if this fall in revenue is replicated in Nexium and Crestor, revenues will fall considerably.ā€

http://seekingalpha.com/article/1367261-will-the-big-pharmaceuticals-fall-off-a-patent-cliff?source=google_news

http://online.wsj.com/article/SB10001424052970203897404578077882348809420.html

http://www.telegraph.co.uk/finance/newsbysector/pharmaceuticalsandchemicals/9813163/AstraZeneca-patents-head-for-cliff-edge.html

4

Thanks Rudra for pointing out the patent-cliff related links.

I was just going through this presentation from Astrazenca site -http://www.astrazenecaindia.com/_mshost1589107/content/navigation/investor-relations/azilcorporatepresentation.pdf/

On page 16, they have given the revenue breakup of their Top 10 brands for Indian operation for FY11, 12 & 9M13. Going by the numbers the combined revenue of the 3 products Neksium,Crestor & Arimidex, which are headed for patent cliff is 7.5% for FY11, & 10% for FY12.

Out of these 3 , arimidex patent has already expired in 2011.

So, it looks like the risk to Indian operation from Patent cliff is lower than the international operation. Is that correct ?

The presentation also throws some more data, i need to spend more time on it to understand their future plans. Overall they are talking about 14-17% growth till 2017.

5

Hi Subash,

I had the same questions in my mind as risk factors, missed writing them, good that you pointed out. My answers are

1). No answers for this one. Needs more investigation.

2). The 74 cr. shouldnā€™t get added to the earnings. But if they are able to get back to their ā€˜pre-innocenceā€™ days, and maintain their margins, net earnings could receive some boost because of the tax adjustments from losses of last year ?

3). We canā€™t count on this one. Because, if they do some structured deal and not sell in the open market, then share price may not be impacted. So fingers crossed for this one.

1).

2).

6

I have few more questions

1). How much EPS they can achive say in 1yr and 2yr

2). What is the expected pe of that time

7

1). I think, if they can get back to Decā€™11 kind of revenue levels, then 600 cr. odd revenue and with a NPM of 13-14% kind of scenario the NP could be around 78-84. i.e., EPS of 31.2-33.6. That could mean a dividend payout of 12-13/-. I am note very sure about how this tax accounting will work for the losses of this year. So, am not taking that into account.

2). Thatā€™s a more tricky one, at 2100 cr MCap itā€™s already trading at 25-27 PE range of this estimated FY14 earnings.

)- If you read this link shared by Rudra, it talks very highly of the new management appointed in Janthis yearand looks like he is taking all the right steps to put the company in growth mode at global level and EM are a focus area.

http://www.telegraph.co.uk/finance/newsbysector/pharmaceuticalsandchemicals/9813163/AstraZeneca-patents-head-for-cliff-edge.html Link: http://www.telegraph.co.uk/finance/newsbysector/pharmaceuticalsandchemicals/9813163/AstraZeneca-patents-head-for-cliff-edge.html

)- Even after shutting down the production facility for this long, the company hasnā€™t reduced itā€™s staff by any significant numbers. Employee strength at end of FY12 was 1674 and as per current update it is 1586. Also there was a VRS scheme offer in FY12 at their Bangalore facility.

)- Am not sure how this new tablet facility is going add to revenue and profitability. Not finding any research reports in the public domain. Did you find any ?

I think 2 senior investors, Ayush and Safir are interested in this stock, probably from much lower levels. Would love to hear their perspective on it.

1).

8

Hi Raj,

Astra Zeneca does interest me. One should try to break the journey of the co in two parts to get a better understanding:

1). Have a look at the co till mid 2011.The co had very attractive nos, consistency etc and used to get very good valuationsā€¦stock used to trade at about 1300-1400 kinda levels. The best part was the excellent profitability, high div payout with very less capital requirements.

2). Now post this, they faced lots of troubles and yet the promoter wanted to delist and was ready to offer a good price. But delisting didnā€™t happen. I also think that the problems were actual, as I took feedback from local medicine shops etc.

And now with the problems getting over (confirmed with doctors that the products are coming back now), the stock was available at 650-700 levels (almost half the price before problems) and hence it seemed very interesting.

On the longer term, if one looks at the size of the parent co - its a $40 Bln co. While indian operations (which are the focus and growth area for everyone) has just 400 Cr turnover as of now. So looking at the dedication of the parent towards the Indian co (they have given a grant of 120-140 Cr), I feel that Indian operations can be scaled up in a big way. One should try to see the possibilites 2-3 years down the line.

For MNCs like this high quality, one can buy them only when they are going through a major problemā€¦otherwise they trade at fancy PE of 30-40ā€¦which we guys donā€™t like :slight_smile:

Ayush

Disc: I hold

1 Like
9

Hi Ayush,

Same question as Subhash about the promoter holding. It is for sure that they will have to reduce their stake prior to June. This may hammer the stock price once the seller announce their plans to sell the shares in open market; thus giving a better entry point.

Are u buying with delisting point of view?

10

Hi Ayush,

Thanks for your comments.

1). You are right, the company seems to have done pretty well, till qtr. end Decā€™11. From Marā€™12 qtr things have changed for worse. But this conincides with their decision to suspend production and recall of steril of products. Are you trying to hint that there were other problems as well on the ground ?

2). Their last offer to delist was in June 2010, at a floor price of 576 and acceptable price of 1152. That was unsuccessful because of defeat in the postal ballot. I think there was no other delisting offer after that, only rumors.

http://articles.economictimes.indiatimes.com/2012-03-06/news/31127455_1_delisting-offer-delisting-plan-astrazeneca-pharma

Absolutely agree with your idea of buying this kind of company when they are going through temporary issues.

Regards

11

Dear Ayush,

Even if Astrazeneca achieves back its peak EPS ever of Rs.30(CY08 EPS 29.53), itā€™s already trading at 30x forward (FY14 or FY15 or FY16 however longer it takes it achieve earlier peak profits). If P/e of 30-40 makes you uncomfortable, its already at lower range of your uncomfort zone. Why do you like it then? Does it make sense to buy it at 30x forward?

12

hi raskhem

I agree about your thesis about company being expensive even on Peak EPS levels.

I think with the possibility of delisting out of the way these companies need to be valued on conventional parameters of PE and cash generation and dividend yield etc.

On all these parameters the current market cap seems to be expensive.

I think they were pushed up into bubble territory in past few months and that bubble now seems to have burst.

I would wait for a few quarters before taking a call.

hitesh.

13

Thoughts on above queries:

1). Donā€™t expect the dilution by the co by selling in open market. Usually these deals are done by doing a placement to a Financial Institution. And the price at which it gets done may be a base for sometime.

2). The understand the possibilities going forward, plz look at the recent presentation very carefully. They are not only going to resume their previous plant with rectification of problems, a new plant (of almost double the current capacity) is also coming up.

If the presentation and recent announcements are true then it seems they are going to focus on India and also expand the product profile.

Based on the above things, it may be a possibility that they aretargeting1000 Cr+ turnover in 2-3 years vs 400 Cr today.

Regards,

Ayush

Disc: As of now, I have a small position and trying to understand thing. Agree that lower levels would be better for accumulation.

14

The company now has a new MD, Mr. Sanjay Murdeshwar, (ex MD of Bayer Pharma Pvt. Ltd.) from May 2nd and has an updated investor presentation on site.

http://www.astrazenecaindia.com/_mshost1589107/content/navigation/investor-relations/13858929/

Few important points from new presentation is:

-Products representing 8-10% of revenue are being discontinued in the current FY.

- The sales trend figures for impacted brands provided in slide 26 is good, and supports the statement given in previous presentation "The re-introduced products have gained ~60 Ć¢ 80% of their peak market share. "

- They do talk about a projected revenue of 1100 cr. in 20016-17.


- I was making an attempt to get some understandings on the trend in EBITDA and PAT margins till 2008 and for 2009 & 2011 (15 months). These 2 periods have distinctly different trends. The EBITDA margin have been in range of min. 24% in 2003 to 34% in 2008 and PAT margins have been in range of 13% in 2004 to peak margins of 20% in 2007 & 2008.

Things have changed for 2009 & 2011(15 months), EBITDA margins came down to of 24% & 18% and PAT came down to 14 & 11%. These figures are much before the controversial time period of product recall etc.. which started from March'12.

Here is the breakup of Revenue figures from 2007 till 2012.

Col 1

2008(2007)

2009

2011(15 months)

2012

Manpower

17%(16%)

21%

25%

30%

Material

27%(30%)

30%

30%

33%

Expense

22%(22%)

26%

27%

30%

Tax,Dividend &
Retained Earning

31%(30%)

22%

17%

6%

No. of employees

1038 (937)

1464 (41%+ yoy)

1705(16.5%+ yoy)

1674

So, it seems a bloated workforce & expenses( mainly sales & marketing ?) contributed to lower margins from 2009 on-wards.

Interesting to note that Mr. Anandh Balasundaram was appointed MD from June 2007 and had joined the org. as VP Sales & Marketing from 2005, had prior experience at Cadbury & Unilever in Sale & Marketing division and is an IITD and IIMA Alumni.

Astrazenca also has a CBI case against itself in his tenure, for supplying false info toDirectorate of Health Services, Delhi to win a business of 10 cr. ??

http://www.firstpost.com/business/astrazeneca-under-cbi-scanner-over-medical-supply-scam-227542.html

However, there is mention of VRS scheme being launched and accepted by 70 ppl in Bangalore facility in 2012 AR report. Will be interesting to note, how the employee strength and manpower cost has moved in 2013, will have to wait for the AR.

To me, now the point to watch out for is, can the company steadily restore it's EBITDA & PAT margins to pre-2008 days while inching towards it's revenue target of 1100 cr. for 2017, and also return back to it's FCF generating and high dividend payout ratio days.

There is some positive announcement towards this in the investor presentation - "The manufacturing of the nontablet impacted products hasbeen outsourced to selectcontract manufacturers in India".

Another point i noted isSalary of Mr. Anandh between 2007-12

2007 - 60 lacs (effective after becoming MD), 2008-1.18 cr., 2009 - 2.08 cr. , 2011 - 2.08 cr., 2012- 2.13 cr.

Between 2007-09 his salary kept increasing by ~100% YoY, while the companies profit showed de-growth of ~10% on a 30% increase in revenue. Talk of some sense of entitlement.

Am happy to see him leave. Let's see how the new MD fares.

15

There is a OFS coming up on 28th, could result into interesting price movement. Letā€™s watch out.

http://www.business-standard.com/article/companies/astrazeneca-pharma-promoter-to-sell-stake-in-indian-arm-113052400861_1.html

16

So guys should we participate in the OFS or not? If we do should it be from trading ora long term hold perspective of 2-3 years?

IMho one can get substantial qty at discount I nthese OFS of which there will be deluge till June 3.

But can AZ face the onslaught of competition of aggressive pharma cos like Mankind n others who are expert in cultivating doctors ? Is AZ a highly ethical co which may find Indian MR led n doctor cultivation market difficult to crack ?

17

ā€œinteresting price movementā€ - Little did i know, it will be so interesting, 19% up yesterday and 14% down today. floor price for OFS is 490. Have your fill, if interested in the company.

18

As per news flash on ET-Now TV channel, majority of the bids were received around the Rs. 543 mark. What could be the implication? Could the stock drift down to that level? Is the OFS process similar to IPO, where the company sets the price based on bids received? Will it not then imply that the existing shares should not quote at too much variance to the OFS allotment price? By when is the process over and when will the price be declared? Would appreciate information from anyone who is familiar with the process.

19

Please go through this link to familiarize yourself with the process

http://www.onemint.com/2012/12/28/offer-for-sale-ofs-process-explained/ Link: http://www.onemint.com/2012/12/28/offer-for-sale-ofs-process-explained/

ā€œOnce the bidding gets over, allotment price is fixed and allocation is done. The successful bidders will be allotted shares directly into their demat account on T+1 basis the very next day. In case of partial allotment or no allotment, the refunds will be made on the same day itself. This makes the OFS process really fast, just like buying shares of the company from the open market.ā€

Coming to your queries, since companies doing an OFS have a lower free float (earlier like AZ had only 10% free float which is now increased to 25% post issue) the OFS can lead to price discovery from broad based participation.

The general market correction (the CMP falling by 16% to 668) should be be more indicative of the discovered price and not the final price of OFS sale, since large issuance need to be made at an attractive discount over prevailing price.

Feel free to ask more questions.

20

The OFS period provided some good entry points and with the absorption of a big stake, any change in performance would be quickly recognised by the markets

Ayush