(Photo: Mint)
(Photo: Mint)

Regulatory scrutiny, acquisitions turning out to be heady mix for Aurobindo Pharma

  • In May, Aurobindo Pharma said that 3 of its active manufacturing units were classified in the OAI category, implying regulatory and/or administrative actions will be recommended
  • Aurobindo Pharma has lost 22% so far this fiscal, almost erasing most of the gains it made last year

Aurobindo Pharma Ltd has been one of the best performing pharma stocks in FY19. Compared to the 9% rise in the Nifty Pharma index, the stock gained 33%. But in FY20, the performance has already reversed. It has lost 22% so far, erasing most of the gains it had made last year.

The stock started retreating as the company’s manufacturing plants increasingly came under the scrutiny of the US drug regulator. In May, Aurobindo Pharma said that three of its API (active pharmaceutical ingredient) manufacturing units were classified in the official action indicated category, implying regulatory and/or administrative actions will be recommended. About 10 days ago, the company said it had received a warning letter for one of the units.

The warning will not disrupt Aurobindo Pharma’s existing business. But, it can delay approvals of products dependent on this plant. Around 28 products manufactured in this plant are currently awaiting approvals.

According to analysts, the other two API manufacturing plants have one common observation with the plant that received the warning letter last month. This is making the Street nervous.

“With a pattern emerging with the issues at all the active pharmaceutical ingredients units, threat of warning letters for its other units cannot be ruled out," Sharekhan Ltd said in a note.

Apart from the above-mentioned three units, Aurobindo Pharma had received observations on two formulation units earlier.

Importantly, these regulatory headwinds are emerging at a time when the company is busy integrating its acquisitions. Over the past year, Aurobindo Pharma has made several acquisitions worth a combined value of about $1 billion, some of which are yet to be completed.

Naturally, this has caused an increase in indebtedness, which means the recent troubles could not have happened at a more inopportune time.

True, the new acquisitions, especially the products acquired from Sandoz Inc., will add to Aurobindo Pharma’s revenues. But costs pertaining to acquisition-related debt and investments in the development of drugs can weigh on earnings, warn analysts.

Vipul Sharma/Mint
Vipul Sharma/Mint

“We believe till the completion of acquisitions, margin expansion and profitability improvement would be restricted due to increase in expenses, interest cost and depreciation," said Sharekhan in its note. “Also, the remediation and site transfer-related costs are likely to put pressure on the company’s near-term margins."

Adding to the concerns is the decline in sales of Sandoz’s products. According to Edelweiss Securities Ltd, Sandoz’s US portfolio has seen a notable fall in sales in the first quarter of the current calendar year, led by a decline in the divested drugs. While price erosion in the US market has been a common feature for some time now, it is crucial that the acquired portfolio does not lose its value too fast.

This combined with resolution of the regulatory challenges at its manufacturing plants will be crucial for the revival of the Aurobindo Pharma stock.