Aurobindo Pharma Is The Cheapest Indian Drugmaker. Or Is It?

Aurobindo Pharmaceuticals Ltd. is the most recommended drugmaker among Indian peers. It’s also the cheapest—a reason analysts often cite for their preference.

Yet, is it actually the cheapest? Because India’s third-largest drugmaker by market value is not strictly comparable with domestic peers. Aurobindo Pharma derives nearly all its revenues overseas, making it more comparable with the likes of Teva Pharmaceuticals Ltd. and Mylan.

And the Indian pharma firm commands a premium over global rivals. That’s because Aurobindo Pharma has a lower cost of manufacturing in India. Besides, it scaled up orals and injectables portfolio in the U.S. despite pricing pressure, allowing a superior execution.

Aurobindo Pharma shares have gained about 8 percent so far this year compared with a 2.9 percent rise in the Nifty Pharma Index. The company, however, trades at a discount to peers because it doesn’t have an India business to cushion from the impact of U.S. pressures, and also hasn’t diversified into higher-margin specialty products in its largest market. And as the international business has a longer working capital cycle, its free cash flows have been inconsistent.

BloombergQuint looks into each of these reasons:

No Domestic Business

Aurobindo Pharma gets nearly 90 percent of its revenue from overseas—half of it from the U.S. alone. Growing competition and price controls in its largest market means it faces pressure on margins, like many of its Indian peers with U.S. sales. Yet, while others have an India business to offset earnings volatility, Aurobindo Pharma doesn’t.

Domestic revenues of companies like Cipla Ltd., Sun Pharmaceuticals Ltd., Lupin Ltd. and Dr Reddy’s Laboratories Ltd.’s rose 20-30 percent in the quarter ended June, according to their filings. That cushioned their overall revenue growth amid tough competition in the U.S. In comparison, Aurobindo Pharma’s U.S. business sales rose 10 percent during the quarter.

Moreover, rising spends on healthcare in the fastest growing economy in the world provides a better growth opportunity in the domestic business.

Lack Of Specialty Portfolio

Aurobindo Pharma is a pureplay cost-efficient generics business catering to developed markets. In comparison, peers like Sun Pharmaceuticals Ltd., Lupin Ltd. and Dr Reddy’s Laboratories Ltd. have now ventured into specialty or biosimilar drugs to diversify their portfolio in the U.S.

Aurobindo Pharma’s R&D costs are about 4 percent of total sales. That compares with Indian peers which spend 8-10 percent of their revenue on developing new products, according to their presentations. R&D costs may increase for Aurobindo Pharma as the company has said that it’s looking to file for complex injectables in the future. A higher R&D spend could lead to some cuts in operating margins.

Challenges In U.S.

Aurobindo Pharma’s U.S. sales have grown 3.5 times in the last five years, driven by high-volume, low-value products. The U.S. growth could slow down given that it doesn’t have large cash-flow generating products, but depends on small or competitive opportunities, according to a report by CLSA. Moreover, revenue from its largest market stagnated in the last five quarters.

Aurobindo Pharma, according to its earnings conference call for the quarter ended June, is banking on all verticals in the U.S. to deliver and remains confident of reporting growth in the ongoing financial year despite a high base in the previous financial year.

Cash Flows

Indian pharma business historically operates at a shorter working capital cycle. The average receivable days in India are less than 30 compared with 60-90 in the international market, according to CLSA. Inventory days in India are around 60 days as against 90-120 for the global market.

Lack of branded presence in India elongates the working capital cycle for Aurobindo Pharma, leading to volatile free cash flows.

While the company’s leverage is low at 0.5 times its equity, inconsistent operating cash flows make reducing debt difficult.