Restate ‘buy’ on Strides Arcolab with a March 2016 target price of R1,353. The stock trades at at 12x FY17e EPS (exclusive R51 for NPV of cash, and R334 for Sovaldi optionality) — a 25% discount to peers, which should narrow going ahead given a robust, vertically-integrated business model, strong earnings visibility, better return ratios and a healthy balance sheet.
We value the stock at 16x FY17e EPS of R60.5 to arrive at a base business value of R968. We see vertical integration and other strategic benefits for Strides after its merger with Shasun.
Strides is set to report 48% earnings CAGR over FY15-FY17e, led by the US/EM markets and institutional business, and better margins. This, along with improving return ratios and a strong balance sheet, should narrow the valuation discount (25%) to peers and lead to a re-rating.
Upside from the Sovaldi optionality lends us further comfort. From a strategic perspective, Shasun’s merger is critical, in our view as its adds vertical integration benefits, provides access to quality infrastructure and a strong R&D pipeline, and offers significant scope for margin expansion given Shasun’s inflated cost base.