By Karthikeyan Thangarajan

India Ratings and Research (Ind-Ra) has revised Aurobindo Pharma Ltd’s (APL) Outlook to Positive from Stable while affirming its Long-Term Issuer Rating at ‘IND AA+’. The instrument-wise rating actions are as follows:

Instrument Type

Date of Issuance

Coupon Rate

Maturity Date

Size of Issue (million)

Rating/Outlook

Rating Action

Fund-based working capital limits

-

-

-

INR42,050 (increased from INR39,340)

IND AA+/Positive /IND A1+

Affirmed; Outlook revised to Positive from Stable

Non-fund-based working capital limits

-

-

-

INR22,890 (reduced from INR25,600)

IND A1+

Affirmed

Commercial Paper Programme*

-

-

-

INR5,000

IND A1+

Affirmed

*This facility is carved out of the existing working capital facilities and not availed as on date.

KEY RATING DRIVERS

Sustained Improvement in Leverage: The Positive Outlook reflects Ind-Ra’s expectation that improvement in APL’s net adjusted leverage seen during 9MFY17 will continue, supported by its strong business profile. Better working capital management led to a reduction in net adjusted debt to INR27.85 billion at end-December 2016 (FY16: INR43.22 billion). Consequently, net adjusted leverage (net debt/ operating EBITDA) reduced to 0.8x (FY16: 1.3x; FY15: 1.6x) and FFO net adjusted leverage (net debt/ fund flow from operations) improved to 1.2x (1.8x; 2.0x). Even after factoring in the INR9.7 billion debt-funded acquisition of Generis Farmaceutica S.A. (Generis) announced in 4QFY17, net adjusted leverage is likely to be about 1x. However, sustaining the EBITDA margins at current levels amid heightened risk of price erosion will remain a key challenge in improving leverage headroom further to absorb any event-induced increase in leverage such as debt-funded acquisitions or adverse regulatory actions. 

Global Scale, Well Diversified:
The affirmation reflects APL’s strong business risk profile as reflected in its large scale of operations which are diversified across geographies, production facilities and dosage forms. Acquisitions along with new product launches led to revenue growth at a 35% CAGR during FY13-FY16 to INR138.96 billion. About 80% of the revenue is from formulation sales and the share of US generic market was about 45% in FY16 (FY13: 30%). Generis acquisition is likely to further moderate geographical concentration. Timely capacity additions focussed on regulated markets have led to a steady moderation of product concentration at manufacturing facility level. Its single largest facility now accounts for 38% of approved abbreviated new drug applications (ANDAs: 59% in June 2015). This has also moderated revenue risk of any potential regulatory actions. The current distribution of pending product approvals is likely to further moderate facility-level concentration. The proportion of revenue from injectables in the US formulation business increased to 15% in 9MFY17 (FY13: 4%) and 39 out of 118 pending ANDAs were injectables. The growing share of revenue from difficult-to-manufacture dosage forms such as injectables is likely to reduce the vulnerability to price erosion risks. 

Healthy Product Pipeline, Organic Growth:
During 9MFY17, APL filed 23 fresh ANDAs (FY16: 22) and received approval for 47 ANDAs (58). Its R&D expenditure increased steadily to 3.5% of the net sales during 9MFY17 (FY15: 2.9%). The strong product pipeline and shifting focus towards differentiated generics provide visibility for profitable growth in the US formulations market. During 9MFY17, revenue from US formulations grew 17% yoy while the overall revenue grew 13% yoy to INR114.48 billion. Ind-Ra expects the strong product pipeline and growing R&D efforts to support organic revenue growth over FY18-FY20. 

Robust Medium-Term Profitability Pointers:
Although price erosion risk will persist over the medium term, Ind-Ra believes that strategic initiatives implemented by APL over the last few years will aid in sustaining profitability over the medium term. The risk emanates from US administration’s focus to reduce drug prices by simplifying approval processes which will increase competition. However, the company has maintained a strong product pipeline due to its continued focus on R&D efforts. It launched 29 new products in the US (including 10 injectables) during 9MFY17. At end-December 2016, the company transferred 63 products to India from EU (28 at end-December 2015). This has permanently improved the EBITDA margins of the company’s erstwhile Actavis portfolio (16% of overall revenue) to 6%-8% from EBITDA losses in FY14. Over 30% increase in API installed capacity achieved over FY14-FY16 has helped the company to achieve more than 70% backward integration (90% for oral solids). Extensive formulation capacity additions made over FY15-FY17 (INR38 billion) will enable the company to produce drugs in large volumes. This is likely to be a key differentiator in a market where channel consolidation has reduced the number of buyers.

Though the operating EBITDA margins expanded at a brisk pace during 1HFY17, high price erosion in APL’s base portfolio in the US generics market due to intensified competition because of the increased rate of new product approvals slowed down margin expansion. EBITDA margins during 3QFY17 shrunk to 22.9% as against the 1HFY17 level of 24.2% (FY16: 23.1%). Further, consolidation of the US pharmaceutical channel that happened over the last few years has considerably reduced the negotiating power for generic drug manufactures and further intensified pricing pressure. 

Healthy Liquidity:
APL’s comfortable liquidity position is reflected in a high free cash balance of INR8.8 billion at end-December 2016 (FY16: INR8.6 billion) and moderate term loan repayment obligation of INR3 billion over FY18. The company is implementing INR23 billion capex over FY17-FY18. Strong operating profitability and improved working capital cycle are likely to result in positive free cash flow over FY18 despite large capex and result in a further reduction of the net debt. 

Exposure to Regulatory Actions:
  APL is exposed to regulatory risks as it derives more than 65% of its income from regulated markets. During 1QFY18, the company received Form 483 observations on two of its formulations facilities in Hyderabad. Ind-Ra understands that these observations are not deemed to be serious and have not affected production or new product approvals. Any adverse impact on EBITDA generation due to regulatory actions can result in a sustained increase in leverage and be negative for the ratings.


RATING SENSITIVITIES

Positive: Ability to improve the operating EBITDA margins leading to FFO adjusted net leverage sustaining below 1.25x while maintaining a strong business risk profile could result in a rating upgrade. 

Negative:
An increase in debt levels due to unplanned debt-funded capex and/or acquisition leading to FFO adjusted net leverage exceeding 1.25x on a sustained basis would result in the Outlook being revised back to Stable.


COMPANY PROFILE

APL, headquartered in Hyderabad, is a vertically integrated pharmaceutical formulations manufacturer. It has 13 formulation manufacturing facilities (three in the US) and 13 API manufacturing facilities. The facilities have regulatory approvals from major international agencies. 


RATING HISTORY

Instrument Type

Current Rating/Outlook

Historical Rating/Outlook

Rating Type

Amount Outstanding (million)

Rating

4 October 2016

23 January 2015

5 November 2013

Issuer rating

Long-Term

-

IND AA+/Positive

IND AA+/Stable

IND AA/Stable

IND AA-/Stable

Fund-based working capital limits

Long-Term/ Short-Term

INR42,050

IND AA+/Positive/IND A1+

IND AA+/Stable/IND A1+

IND AA/IND A1+

IND AA-/IND A1+

Non-fund-based working capital limits

Short-Term

INR22,890

IND A1+

IND A1+

IND A1+

IND A1+

Commercial paper programme

Short-Term

INR5,000

IND A1+

IND A1+

-

-


COMPLEXITY LEVEL OF INSTRUMENTS

For details on the complexity levels of the instruments, please visit https://www.indiaratings.co.in/complexity-indicators.

SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Applicable Criteria

Analyst Names

  • Primary Analyst

    Karthikeyan Thangarajan

    Associate Director
    India Ratings and Research Pvt Ltd 4th Floor, D South, TIDEL Park No 4, Rajiv Gandhi Salai, Taramani Chennai 600 113
    +91 44 43401712

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121