Strides to benefit from specialty business

Strides Arcolab, a leading midsize pharma company, stands to benefit from its higher focus on specialty business, apart from getting steady revenues from sales of low-cost generics to mature markets.

Business: Bangalore-based Strides Arcolab is engaged in developing and manufacturing wide range of IP-led niche pharmaceutical products with an emphasis on sterile injectables. The company has 14 manufacturing facilities across six countries and caters to over 75 nations.

The company operates under two segments — the specialised sterile products business, Agila, and the pharmaceutical business segment.

Specialty business: Strides develops and manufactures specialty injectables across key therapeutic domains like anti-infectives, oncology, analgesic, central nervous system (CNS), gastroenterology, ophthalmics and peptides. The firm derives almost 39% revenues and about 57% of total Ebitda from this division. This high margin business, with Ebitda margins of 32%, has been growing at a fast pace and would be the core business driver.

Pharmaceuticals segment: This business is divided into two product lines—manufacturing and branded generics. Strides is one of the leading manufacturers of soft gelatin capsules and also supplies oral products globally for fighting diseases like AIDs and tuberculosis  under its global disease initiative. The company sells branded generics in regulated markets such as Australasia, Africa and India. This division contributes 61% to topline and 43% to operating profits, as the margins are lower at 14-16%.

The firm’s revenues are diversified across geographies with Australaisa, America and Europe contributing 33%, 21% and 19%, respectively, while Africa and rest of the  world contribute remaining 27%.

Investment Rationale: Strides has been increasing its focus to get higher revenues from high margin and less competitive specialties business as large number of patents in injectable oncology segment are expiring by 2015, opening up huge potential market. The firm, which has received maximum ANDA approvals in last three years, is set to capitalise on shortage of drugs in the US, more than half of which are in sterile.

Strides has a strong product portfolio. Over the last five years, the firm has made 115 cumulative ANDA filings, out of which 35 have been approved while only 10 of those have been commercialised.

Outside the US, the company has made 482 cumulative filings in emerging markets and 136 in other regulated markets out of which 314 and 47 have been approved, respectively. The company is set to benefit from additional capacities once approved. The company has recently got USFDA nod  for its new sterile plants in Bangalore paving way for commercial supplies of approved products to the US markets, adding to the revenues.

The firm derives significant amount of licensing income (received close to Rs450 crore in CY10) as it has struck deals with global firms like Pfizer, GSK, Aspen etc. With close to 52 products in pipeline, which are not yet licensed, Strides expects to receive Rs250-280 crore of licensing income this fiscal. Its foray into biosimilars, with 70% acquisition of Inbiopro Solutions, opens up potential for generic sales in developed markets once regulations are set.

Concerns: The company faces industry-specific risks like delay or failure in getting approvals, delay in launching products and currency fluctuations risk. The firm’s high debt and leverage ratios pose a concern but the same are expected to improve led by healthy income growth.

Valuations: On the back of strong product lineup, higher capacity utilisation in specialty business, growth in branded pharmaceuticals and global disease initiative programmes, the company’s revenues are expected to grow at CAGR of 23% over CY10-CY12E. The higher contribution from high margin specialty segment would lead to over 36% CAGR growth in net profits over the same period. At current market price of Rs372.90, the stock trades at P/E of 11.78 times its expected CY11 earnings per share and 9.13 times its CY12E earnings, respectively. Investors with long-term view can consider the stock on declines.

Disclaimer: The writer does not hold any shares in the company.