Big build-up, small payoff for Aspen

 By: Stafford Thomas                                       Published on: 17 March 2017

Source: Financial Mail

Rapid expansion has taken a toll at the generic pharmaceuticals giant, with disappointing results and high turnover.

Aspen’s year to June 2017 was meant to be the one in which the pharmaceutical group’s past three years of massive transformation and internationalisation were finally to pay off.

“You can expect very strong earnings growth this [financial] year, especially in the second half,” CEO Stephen Saad told Financial Mail in October last year.

At the half-year mark, however, it seems the company will fall short on delivery of that big promise.

Far from super growth, the group managed no better than a 6% rise in normalised headline EPS (HEPS) in its half-year to December.

“It was not a good result,” says Alec Abraham of Sasfin Securities.

The result was all the more disappointing given that it included four months of results from AstraZeneca’s (AZ) anaesthetics portfolio outside the US. This was acquired in a US$770m deal done last September.

The AZ portfolio added revenue of R1.6bn and was the key factor in a 13% rise in group revenue to R19.8bn. Excluding the portfolio, revenue lifted a weak 4%.

Arguably, Aspen is showing all the signs of stress of a company that has undergone major structural change.

Aspen’s bold moves over the past three years have enabled it to become the world’s sixth-largest generic pharmaceuticals group.

These have included the acquisition of off-patent thrombolytic and therapeutic anticoagulant drug brands and their intellectual property rights in deals totalling more than R20bn.

Aspen has also expanded its manufacturing capability and distribution reach aggressively. The group now has offices in 70 countries and representatives in 150 countries.

It represents a platform Saad has said can support a business twice the size Aspen is now.

Management admits that rapid expansion has taken a toll, noting in its interim results release: “There have been resultant inefficiencies in overhead structures and working capital management which continue to receive high levels of focus.”

Also of concern is that rapid change does not seem to be going down well with many of Aspen’s 10,000 employees. Staff turnover jumped from 17% in 2014 to 25% in 2015, and eased only slightly to 24% in 2016.

Even on its home turf in sub-Saharan Africa things have gone awry, with supply chain problems blamed for pharmaceutical sales falling 8% to R3.4bn in the interim reporting period.

On a cautiously positive note, Abraham
says: “Management appears to have its hand on problems.”

Encouragingly, there was a sign of better working capital management in the six months to December. Reflecting this, cash flow after tax jumped to R3.2bn from R1.5bn a year earlier.

The second half of the year to June 2017 should deliver improved results, management promises. Among the positives, a “substantial” recovery in sub-Saharan operations is under way and the AZ anaesthetics portfolio will be included for a full six months.

Another boost will come from the inclusion, from March 1, of GlaxoSmithKline’s (GSK) anaesthetics portfolio outside the US, acquired for £280m.

The AZ and GSK portfolios add some $670m to Aspen’s annual revenue and take its share of the anaesthetics market outside the US to more than 20%. But the promise of a better second six months comes with a word of caution from Aspen. Rand strength will “dilute foreign earnings”, which make up 80% of total earnings.

In the longer term, Aspen faces another potential earnings diluter. It comes from a concerted effort by governments across the world to counter spiralling drug costs.

Aspen is to an extent protected by its strategy of focusing on complex generic drugs, where barriers to entry by cut-throat-pricing generic producers are high. But it is not foolproof protection.

The pressure is already on, with Aspen reporting an annual revenue loss of €14m from its thrombolytic drug portfolio in Eastern Europe as a result of pricing pressure.

In Australia, a R2.5bn annual revenue market for Aspen, legislation has led to big cuts in generic drug prices. It’s an ongoing process, with another round of cuts due next month.

The picture is similar in many countries. For example, in Japan, an R800m annual market for Aspen, pressure is on for an annual drug price review. In Germany many drug prices have been frozen since 2010, while in Ireland the Health Service Executive has been given the power to set drug prices unilaterally.

Aspen will no doubt be hoping to reduce the impact of legislated pricing pressure through its entry into China, where it aims to rapidly build annual sales to R2bn.

However, Aspen’s China entry comes at a time when the country’s government has launched an intense campaign to persuade drug producers to cut prices.

By no means do the headwinds facing Aspen make it incapable of resuming a growth trend that resulted in its HEPS rising at an annual average of 17% in the 10 years to June 2016.

But for now, given the uncertainties, Aspen on a 25 p:e appears at least fully priced.

Source: Financial Mail