Aspen Pharmacare bounces back
South Africa’s largest pharmaceutical manufacturer, Aspen Pharmacare, may have announced a relatively tepid set of annual results for the year ended 30 June 2019, but the anticipation of a reduced debt load freeing up cash flows pushed its share price up 12% the day after its results announcement.
In August Aspen’s share price touched nine-year lows after it declared an £8m ($10m) fine for anticompetitive behaviour in the UK. Weighing on a company with hefty borrowings, the fine – while not overly significant for a highly cash-generative business such as Aspen – stretched investor sentiment before its results announcement.
- Since then, the pharma group’s share price has bounced back more than 40% with a string of good-news announcements.
- While revenue increased just 1% to R38.9bn ($2.7bn), normalised EBITDA was down 2% to R10.8bn thanks to an 11% drop in contribution from manufacturing operations and HEPS was down 7%.
- The 27% reduction in borrowings to R38.9 billion from R53.5 billion at the end of December was most significant for shareholders.
Non-core businesses sold
Aspen, which is based in Durban, declared no dividend for the first time in nearly a decade as the group continues to make headway in reducing its debt burden. Though Aspen described its leverage ratio as “comfortably below” its covenant threshold of 4x, at 3.62x, shareholders will be pleased with CEO Stephen Saad’s intention to drive it lower to 3x by 2020.
During FY2019 the group sold non-core and discontinued operations for R12.3bn, making a net profit of R5.7bn from the sale of its nutritionals business, allowing Aspen to focus more closely on its pharmaceutical brands – especially anaesthetics, alongside its thrombosis and localised pharma brands.
Developed Europe and Sub-Saharan Africa are by far its two most significant revenue contributors from the 56 countries in which it has a presence, with 31% and 22% of revenue respectively. Aspen aims to focus on bolstering its anaesthetics business in South Africa and developed Europe over the next five years, improving its manufacturing capability and reducing costs to raise its margins.
At the results presentation Saad said Aspen had met most of its short-term targets for the year, particularly as they pertained to reducing debt. But more good news was to follow, with the announcement that Aspen is set to sign a major deal with an Indian supplier of active pharmaceutical ingredients, which it uses to manufacture HIV/Aids drugs.
Aspen recently won another tender to continue supplying the South African government, which treats millions of Aids patients monthly, with anti-HIV drugs for the next three years. In this high-volume, low-margin model where input costs make up the majority of the costs of the drugs, Aspen has been exposed to dollar-priced ingredients. The new deal with its Indian supplier will shift the burden of currency swings to the supplier and improve Aspen’s margins.
The following day, Aspen announced that the US Food & Drug Administration had approved its single-dose preterm birth prevention drug, which it will manufacture and distribute in the US in a profit-share partnership with a local partner, further raising anticipated cash flows.
In conjunction with reduced borrowings, a capital expenditure programme scheduled to relax in 2020, and the resumption of Aspen’s sales of blood-thinning heparin medication to third-party customers, investor optimism is reflected in a continuing share price bounce through the week.
Asief Mohamed, chief investment officer at Aeon Investment Management, said Aeon had sold out of Aspen earlier this year, uncomfortable with Aspen’s relaxed approach to its debt covenants at a position above 3x. But Saad’s moves to lower debt are not be enough to entice Mohamed back to buying into the company.
- “In some ways shareholders were expecting the worst, and these results were less bad than anticipated, so the share price has bounced up. But management has essentially admitted to overconfidence in deals in which they probably overpaid for assets, much like Woolworths with its David Jones acquisition in Australia,” Mohamed says.
- He says Aspen’s cheap pricing made it an attractive short-term investment option, but in a year’s time he wasn’t sure the group could achieve and maintain above-inflation revenue and earnings. “They’re still not getting the returns on invested capital we’re looking for, and reduction in debt may come at the expense of margin growth with their current product set.”
Mohamed feels large-scale buyers of medications such as the Discovery medical aid provider and the South African government have enjoyed power to push down prices as well as opting for alternatives, and regulators have backed public opinion on drug costs. “It is difficult to get good prices these days because sentiment and stiff competition works against Aspen. We think the fundamental outlook is not great, though some institutional investors are buying in at these levels so perhaps there is a lot of belief that management can continue turning Aspen around,” he says.