Stock corner: ‘Buy’ on Aurobindo Pharma, Unit 4 issues will need robust efforts

The USFDA inspected Aurobindo Pharma’s (ARBP’s) Unit 4 from 4th-13th Nov’19 and issued form 483 with 14 observations.Observations are largely related to deficiencies in studies and monitoring conditions necessary for aseptic processing/injectable facility. It would take 4-6 months of enhanced efforts to resolve the issues, in our view. Unit 4 accounts for 7-8% of US sales and has 47 ANDAs pending for approval.

Despite intensifying regulatory headwinds over the past 8-9 months, ARBP has been able to maintain growth momentum in US generics (+27% y-o-y in 1HFY20) on the back of new launches and acquisitions. Further, it has a healthy pipeline of 153 ANDAs pending for approval in US generics. Separately, EU business profitability is on track owing to its foray into newer markets and shift in product manufacturing to India. We value ARBP at 8x 12M forward earnings and arrive at a target price of `500. Maintain Buy.

Highlights of Unit 4 form 483

The USFDA inspected Unit 4 as part of cGMP compliance and thereafter issued form 483 with 14 observations (this site has successfully closed inspection six times in the past). The inspector observed deficiencies in media fill studies representing the manufacturing process. Other notable observations were (a) sampling plan not representing worst-case activities and (b) deficiency in systems for maintaining any equipment used to control aseptic conditions. All these showed deficiency in the assuring aseptic processes in manufacture of sterile products. A robust response followed by implementation of CAPA would be needed to resolve the issues within the 3-6 month timeframe.

Regulatory risk has intensified

Over the past one year, eight sites have been inspected by the USFDA. Units 1 and 11 have been classified as Official Action Indicated (OAI) and Unit 9 has been issued a warning letter recently. Unit 7 is issued form 483 with seven observations. Units 5 and 8 were issued form 483 with four observations each.

Unit-4 contributes ~7-8% of US sales

Auromedics comprises injectables from Unit 4, Eugia, Unit 12, Unit 16 and Auronext. It formed ~19% of US sales at end-Q2FY20. Excluding sales from Eugia, Units 12/16 and Auronext, Unit 4 would form ~7-8% of $1.5 bn US annual sales.

Valuation and view

Regulatory risk has increased with escalation to OAI/WL at a few sites. However, US generics growth for ARBP is improving due to new launches/acquisitions. Further, EU (30% of sales) is penetrating into newer markets and improving margins by shifting manufacturing to India. We value ARBP at 8x 12MF earnings (40% discount to three-year average).