Babystep in US OTC Diversifying patent cliff uncertainty November 13, 2014 Surajit Pal surajitpal@plindia.com +91 22 66322259 Rating BUY Price Rs1,062 Target Price Rs1,308 Implied Upside 23.2% Sensex 28,009 Nifty 8,383 (Prices as on November 12, 2014) Trading data Market Cap. (Rs bn) 309.5 Shares o/s (m) 291.5 3M Avg. Daily value (Rs m) 3330 Major shareholders Promoters 54.10% Foreign 27.72% Domestic Inst. 7.95% Public & Other 10.23% Stock Performance (%) 1M 6M 12M Absolute 13.1 79.9 290.5 Relative 6.6 60.9 252.4 How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2015 55.0 54.7 0.7 2016 65.1 65.7 0.8 Price Performance (RIC: ARBN.BO, BB: ARBP IN) (Rs) 1,200 1,000 800 600 400 200 0 Nov 13 Jan 14 Source: Bloomberg Mar 14 May 14 Jul 14 Sep 14 Nov 14 Aurobindo has forayed into OTC (Over the Counter) business in the US with the acquisition of Natrol Inc. Aurobindo s bid of US$132.5m was highest in bankruptcy auction of Natrol Inc while the second highest bidder, PE firm ICV Partners, was way below at US$90m. Natrol is one of the largest suppliers of vitamins and nutritional supplements to major retailers and specialty organisations in US and owner of many valuable brands such as Prolab, MRI, NuHair etc. With low leverage ratio of 0.7x, we expect the company to utilise new loan as source of fund for the acquisition though the company has not identified anything in specific. While appearance of the acquisition seems unusual for a generic company, Aurobindo s objective in its first step for OTC business aims at diversification of risk in US generic as higher uncertainty of patent cliff looms large post 2016. Aurobindo s bid price of US$132.5m was at 1.7x of CY13 sales. We expect Aurobindo to continue to explore further foray into US OTC market and expand other key geographies till it establishes the new business unit as critical contributor in the company. We are however awaiting further management clarification on the financials and strategic plan of the company. Once available, we would incorporate potential earnings from Natrol Inc. in our EPS estimates of FY15E and FY16E. We maintain BUY and retain TP of Rs1,308. Key financials (Y/e March) 2013 2014 2015E 2016E Revenues (Rs m) 58,553 80,385 117,377 134,274 Growth (%) 26.5 37.3 46.0 14.4 EBITDA (Rs m) 8,610 20,715 26,175 30,883 PAT (Rs m) 4,292 13,759 16,040 18,978 EPS (Rs) 14.7 47.2 55.0 65.1 Growth (%) 1.9 220.3 16.6 18.3 Net DPS (Rs) 1.5 1.3 1.3 1.3 Profitability & Valuation 2013 2014 2015E 2016E EBITDA margin (%) 14.7 25.8 22.3 23.0 RoE (%) 17.4 43.3 37.3 33.0 RoCE (%) 8.9 21.4 21.8 22.8 EV / sales (x) 5.8 4.3 2.9 2.5 EV / EBITDA (x) 39.7 16.6 12.9 10.8 PE (x) 72.0 22.5 19.3 16.3 P / BV (x) 11.9 8.3 6.4 4.7 Net dividend yield (%) 0.1 0.1 0.1 0.1 Source: Company Data; PL Research Event Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
The key takeaways of the acquisition of Natrol Inc The event of acquisition: Aurobindo won a bankruptcy auction for Natrol Inc in US offering US$132.5m to acquire the company. Media information, cited court documents, suggested that Aurobindo has agreed to pay off some unpaid bills of Natrol in addition to pay off the bid price. Aurobindo s bid price was higher than the second highest bid of US$90m by private equity firm ICV partners. Natrol Inc manufactures and sells vitamins and nutritional supplements in US with sales of US$80m in CY13 and US$60m in H1CY14. Previously, Natrol was acquired by India s Plethico Pharma at US$82m (@US$4.4/share in cash) in 2008 and remained its subsidiary till date. What triggered the acquisition: Natrol Inc. filed chapter 11 bankruptcy protections in June 2014 in US, under pressure to repay loan of US$69.3m to its prime lender Cerberus Business Finance LLC. With legal persuasion from secured and unsecured lenders, the Natrol management eventually agreed to sell the company for paying off the lenders. The bid price of Aurobindo ensures creditors, secured and unsecured, of being fully paid against their loan of US$100m to Natrol Inc. As per court filings in June 2014, Natrol has US$500m assets and US$100m liabilities which include US$69m to Cerberus and US$22m other liabilities (including US$9.6m in pre bankruptcy liabilities). Valuation multiple for the acquisition: At a current bid price of US$132.5m, Aurobindo paid 1.7x and 1.1x of sales CY13 and CY14 (post extrapolating sales of H1CY14). With strong competition of brands and lower operating (EBITDA) margin, Aurobindo s pay off valuation of Natrol seems to be lower than current trend of valuation for acquiring an OTC company in the US which is at around 2x 3x of sales. Aurobindo believes that streamlining of current operation would expand operating margin in the near term. With better management and zero leverage, management expects opportunity for operating and financial leverage in Natrol and reduce current estimate of payback period significantly. The acquisition however will increase debt in Aurobindo in near term while the company s current leverage ratio remains low at 0.7 Comparison of Dr Reddy s acquisition of Leiner in US: With its foray into nonethical (non prescription) segment, Aurobindo shows strong intent to kick start its OTC business in US. We find the only comparing example among Indian companies to be Dr Reddy s acquisition of Carlson, US based Leiner Health Products way back in 2003. Leiner was one of the largest suppliers in US of OTC drugs and nutritional supplements which used to be supplied to Target and Wal Mart. Incidentally, Dr Reddy s acquisition of Leiner was also occurred post bankruptcy filing of Leiner in US. November 13, 2014 2
Though unrelated, Natrol to kick start Aurobindo s foray in OTC: While Aurobindo s expertise in ethical segment renders the acquisition as unrelated expansion, we believe that Aurobindo aims at diversifying risk in US generics as greater uncertainty of patent cliff looms large post 2016. Going forward, we believe Aurobindo would explore further to expand OTC portfolio in US and other key geographies through organic and inorganic routes. Brief history of Natrol in US: Founded in 1980 and based in California, US, Natrol Inc. is OTC suppliers to major retailers with natural products such as acai berry and melatonin as well as vitamins and sports nutrition line of products. Its other products are digest and weight management; products and formulas for hair, skin and nails; card/hunger/fat intercepts; metabolism boosters and super fruits. There were three class action lawsuits against the company on advertised claim of glucosamine based products, which were however stayed post bankruptcy filing of the company in US District Court of Delaware. We have no clarity from the management whether the cases would start proceedings once Natrol comes out of Chapter 11 in US. Distribution channels and brands: The key brands in US of are Natrol, MRI, Prolab, NuHair, Laci Le Beau, Promensil and Shen Min while the company has wide range of distribution network across US such as: Drug stores: Walgreens, CVS Pharmacy, RITE AID Clubs/MMs: Sam s Club, Costco, BJ s Wholesale club, Wal Mart Health Food & Specialty: GNC, Whole Foods, The Vitamin Shoppe E commerce: vitacost.com, drugstore.com, walgreens.com, bodybuilding.com Gymnasiums: Gold s Gym, Power House Gym, 24 hour Fitness, Lifetime Fitness Grocery: Albertsons, Kroger, Safeway November 13, 2014 3
Income Statement (Rs m) Net Revenue 58,553 80,385 117,377 134,274 Raw Material Expenses 29,908 36,060 53,055 60,423 Gross Profit 28,646 44,325 64,323 73,851 Employee Cost 6,633 8,319 14,085 15,442 Other Expenses 13,403 15,290 24,062 27,526 EBITDA 8,609 20,715 26,175 30,883 Depr. & Amortization 2,487 3,125 3,777 4,510 Net Interest 1,313 1,079 779 732 Other Income 285 846 291 294 Profit before Tax 5,094 17,356 21,911 25,935 Total Tax 827 3,635 5,916 7,002 Profit after Tax 4,267 13,721 15,995 18,933 Ex Od items / Min. Int. (1,353) (1,600) Adj. PAT 4,292 13,759 16,040 18,978 Avg. Shares O/S (m) 291.2 291.5 291.5 291.5 EPS (Rs.) 14.7 47.2 55.0 65.1 Cash Flow Abstract (Rs m) C/F from Operations 2,749 5,188 15,319 15,073 C/F from Investing (2,463) (7,987) (5,396) (9,500) C/F from Financing 1,081 2,558 (11,772) (4,497) Inc. / Dec. in Cash 1,366 (242) (1,849) 1,076 Opening Cash 656 2,027 1,786 (64) Closing Cash 2,027 1,786 (64) 1,012 FCFF (3,882) 2,773 7,411 4,386 FCFE (439) 4,760 (67) 1,714 Key Financial Metrics Growth Revenue (%) 26.5 37.3 46.0 14.4 EBITDA (%) 40.3 140.6 26.4 18.0 PAT (%) 2.0 220.6 16.6 18.3 EPS (%) 1.9 220.3 16.6 18.3 Profitability EBITDA Margin (%) 14.7 25.8 22.3 23.0 PAT Margin (%) 7.3 17.1 13.7 14.1 RoCE (%) 8.9 21.4 21.8 22.8 RoE (%) 17.4 43.3 37.3 33.0 Balance Sheet Net Debt : Equity 1.2 0.9 0.6 0.4 Net Wrkng Cap. (days) 216 223 146 151 Valuation PER (x) 72.0 22.5 19.3 16.3 P / B (x) 11.9 8.3 6.4 4.7 EV / EBITDA (x) 39.7 16.6 12.9 10.8 EV / Sales (x) 5.8 4.3 2.9 2.5 Earnings Quality Eff. Tax Rate 16.2 20.9 27.0 27.0 Other Inc / PBT 5.6 4.9 1.3 1.1 Eff. Depr. Rate (%) 6.6 7.2 7.9 7.9 FCFE / PAT (10.2) 34.6 (0.4) 9.0 Source: Company Data, PL Research. Balance Sheet Abstract (Rs m) Shareholder's Funds 26,058 37,502 48,608 66,359 Total Debt 34,445 36,431 28,953 26,281 Other Liabilities 790 2,310 344 (219) Total Liabilities 61,292 76,243 77,905 92,421 Net Fixed Assets 28,574 30,314 31,904 36,894 Goodwill Investments 223 198 223 223 Net Current Assets 29,881 37,657 44,213 54,892 Cash & Equivalents 2,085 1,786 (64) 1,012 Other Current Assets 39,283 54,526 63,415 76,746 Current Liabilities 11,486 18,655 19,138 22,867 Other Assets 2,615 8,075 3,431 4,094 Total Assets 61,292 76,243 79,771 96,103 Quarterly Financials (Rs m) Y/e March Q3FY14 Q4FY14 Q1FY15 Q2FY15 Net Revenue 21,355 23,059 28,946 28,622 EBITDA 6,388 7,190 6,417 6,182 % of revenue 29.9 31.2 22.2 21.6 Depr. & Amortization 760 880 908 899 Net Interest 237 342 189 210 Other Income 107 701 287 43 Profit before Tax 5,497 6,669 5,607 5,117 Total Tax 1,336 1,653 1,464 1,404 Profit after Tax 4,175 5,018 4,154 3,722 Adj. PAT 4,175 5,018 4,154 3,722 Key Operating Metrics (Rs m) US Formulations 17,526 34,028 39,023 48,131 EU & ROW 8,843 11,355 39,400 43,220 ARV formulations 7,503 8,402 9,242 10,074 APIs 25,362 28,642 32,409 35,957 Source: Company Data, PL Research. November 13, 2014 4
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai 400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage % of Total Coverage 60% 50% 40% 30% 20% 10% 0% 51.4% 31.8% 15.9% 0.9% BUY Accumulate Reduce Sell PL s Recommendation Nomenclature BUY : Over 15% Outperformance to Sensex over 12 months Accumulate : Outperformance to Sensex over 12 months Reduce : Underperformance to Sensex over 12 months Sell : Over 15% underperformance to Sensex over 12 months Trading Buy : Over 10% absolute upside in 1 month Trading Sell : Over 10% absolute decline in 1 month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. We may from time to time solicit or perform investment banking or other services for any company mentioned in this document. November 13, 2014 5