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Where to for market darling?

Aspen’s disappointing results raise questions about future growth.

Whichever way you try to slice it, Aspen’s 5% revenue growth in constant currency was never going to satisfy a market that expects double-digit growth from the pharmaceutical company. The share price, which was priced for stellar growth, fell almost 24% to R210.45 when results were released last Thursday, recovered slightly, and the fell another 18% on Friday, closing at R188.45.

Aspen generated R42.6 billion in revenue and R12 billion in earnings before interest, tax, depreciation and amortisation in the year ended June 30, 2018. Headline earnings per share rose 13% to R14.69, while normalised heps rose 10% to R16.05 cps.

Performance was patchy. Aspen’s emerging markets businesses came to the party, particularly the anaesthetic and thrombosis portfolio, with growth of 27% and 18% respectively. This was far healthier than the 16% and 7% growth for the same portfolios in developed markets.

But the company was let down across all of its territories by its high potency and cytotoxic (cancer) drugs with revenue declining by over R500 million. Negative growth was attributed to increased generic competition in Europe, challenges in the US and trouble in Russia.

Regional brands showed good revenue growth in sub-Saharan Africa and Asia, with developed markets again underperforming. In addition, Aspen’s manufacturing business and the nutritional business also underperformed. Manufacturing lost some significant tenders on the fixed dosage formation while simultaneously experiencing pricing pressure in some active pharmaceutical ingredients products. This resulted in a 23% revenue decline and a R250 million impact on group Ebitda. A disappointing performance from its infant milk formula business (nutritionals) resulted in a revenue decline of R133 million.

Speaking to Moneyweb, Aspen’s deputy group CEO Gus Attridge pointed out that while 5% growth across the group may look anaemic, certain divisions performed far better. In particular, he said, the commercial division, which accounts for 78% of group revenues, achieved 8% growth. Of this, 4.5% was organic. “This is a sound performance – specifically in our emerging market region, which we hope will anchor our business going forward.”

He added that the group is looking for acquisition opportunities that tie into areas of focus, also in emerging markets. Aspen is first and foremost an emerging markets player, he says. “We are taking critical medicines, of the highest quality, into emerging markets where the demographics are favourable and where we believe we will continue to grow.”

While emerging market growth is certainly a positive feature of these results, it is also true that developed markets dragged the numbers down. “With Aspen historically trading on a PE multiple above 20, the market is not prepared to accept numbers like this,” says Reuben Beelders, a portfolio manager with Gryphon Asset Management. “This is an example of a company that has gone through a tremendous growth phase – bolstered by pricey acquisitions, which it is finding difficult to sustain. The share price action yesterday reflects the stock now coming down to earth, as expectations are lowered and realism returns.”

There is no disputing that Aspen is a great South African success story and during the results presentation, CEO Stephen Saad spent some time reflecting on the company’s 20 years as a listed entity, during which time it has delivered compound annual growth in headline earnings per share of 26%.

Source: Aspen results presentation, 2018

“Aspen is known for delivering persistently high growth in earnings,” says Zwelakhe Mnguni, chief investment officer at Benguela Global Fund Managers. “To fully understand the growth phenomenon, note that Aspen grew normalised headline earnings per share at an annualised rate of 26% per annum over the 20 years to 2018 while the market only managed to deliver 11% over the same period.”

In return, he says, over this 20-year period, the market rewarded Aspen with an average P/E ratio of 22x versus 15.3x for the Alsi. In fact, since 2012, Aspen has consistently traded at a significantly higher P/E multiple than that of the market and above one standard deviation of its own historic average P/E ratio. “This has been a huge vote of confidence on the ability of the business and management to continue delivering phenomenal growth in earnings. In hindsight, the market has been consistently overestimating Aspen’s returns when management’s focus was on growth. This is why we are seeing a severe reaction in the share price over the past two days.”

But concerns have surfaced that the company is too obsessed with revenue and earnings growth, at the expense of returns on invested capital, a critical business measure.

“I couldn’t help but notice that instead of showing 20 years of returns on invested capital [ROIC], Stephen [Saad] showed 20 years of normalised Heps growth at a compound annualised growth rate of 26%. If he had shown the ROIC profile, investors would have seen that as a consequence of the acquisitive growth ROIC fell from 28% in 2007 to 6% in 2018.  

“He [Saad] spent a lot of time talking about the major transactions they concluded to transform the business to a global player. However, he uses revenue growth as a measure of success which we believe is a wrong measure. Growth is only valuable to companies that meet the cost of capital. Aspen is not meeting the cost of capital currently at 6-7% return on invested capital for three years in a row now.  If organic growth continues to slow down as it has, returns will become a key focal point for investors,” he says.

Financial year

Key acquisitions

1999

South African Druggists

2009/2010

Specialist global brands from GSK (including Eltroxin, Lanoxin, Imuran & Zyloric and Alkeran, Purinethol, Septrin & Trandate). They contributed 60% (R2.7bn) to High Potency category in FY 2018

2010

Beginning of Sub Saharan collaboration with Glaxo Smith Kline

2011

Addition of Sigma business to Aspen Australia

2011-12

GSK’s over the counter brands

2013-14

Nestlé’s infant nutritionals portfolio

2014-15

In total five thrombosis transactions, including the GSK thrombosis business and products from Novartis and MSD

2014

MSD’s API facility (active pharmaceutical ingredient)

2017-18

Anaesthetic portfolios from GSK and Astra Zeneca

Source: Aspen data

Aspen switched its focus from generics to niche, branded products back in 2014 when it became apparent that generics was a high volume, low margin business.“To grow they need to keep on buying products that other companies don’t want and trying to sell them better,” says Beelders. “It is not a bad model, but they are never going to come up with a Viagra, and one must be realistic about one’s expectations, and the price you pay for those expectations.”

For Saad and Attridge the focus is to continue to build on their commercial pharmaceutical base, which offers consistent and predictable growth while exploiting growth opportunities in China as well as the US market. Manufacturing business challenges, regulatory hurdles in developed markets and rising supply costs are headwinds that will be faced as they continue to streamline the business and enhance efficiency. 

Aspen headwinds impact share price

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A few years ago the CEO said that if there is one part of the business he would keep for himself, the part he is most exited about, is the baby formula development in China. So they took on all the debt, and now they were forced to pawn the crown jewels. The share price overcompensated for the growth story, and now it will overcompensate for the loss of trust in management. This combination of negative emotions will drive the price all the way down to R100 in MHO.

What is there to buy on the JSE? In all my time I have never seen such a sick market. The Satrix SP500 and the Nasaq 100 are the only opportunities on the JSE at the moment. The rest are mangy dogs.

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