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Costly Pill

Aurobindo Pharma is a market leader, but its stock is currently expensive & better avoided…

I am interested in buying shares of Aurobindo Pharma. Does the company have good prospects? I am a long-term investor and would not mind holding the stock for two to three years.
- P.S. Venkatesh

From being chiefly into active pharmaceutical ingredients (APIs), Aurobindo Pharma has transformed itself into a global formulations player. It is a market leader in segments such as semi-synthetic penicillin and cephalosporins. In Q2FY12 the company posted lower-than-expected top-line, operating profit, and profit after tax numbers. Lower growth in the company’s top line was because growth in the formulations segment faltered.

In the first half of FY12, Aurobindo Pharma’s performance was affected by lower sales of formulations, subdued demand in Europe, disruption in operations due to regional unrest, and the impact of a USFDA alert on the company’s Unit VI Cephalosporin manufacturing facility.

The company’s transformation from being a pure API supplier to becoming a formulations player has increased its cost efficiencies, as 90 per cent of its formulation production is backward integrated. Further, commencement of operations at its Hyderabad SEZ facility and incremental contribution from a deal with Pfizer are expected to boost the company’s earnings and provide better growth visibility. It is expected to post a net sales CAGR of 12.7 between FY11 and FY13 on account of new supply agreements and the US antiretroviral (ARV) formulation contracts.

Aurobindo Pharma is one of the largest generic suppliers under ARV contracts, with a 35 per cent market share. The company enjoys high market share as it is fully integrated in all its products, apart from having a large product basket. The stock is currently trading at a consolidated price-to-earnings (P/E) ratio of 21.36. At this level, it is trading at a premium of 81 per cent over its five-year median P/E (11.89). Over the last five years, the company’s (trailing 12-month) earnings per share has grown at a CAGR of 3.6 per cent. This gives it a very unattractive price-earnings to growth ratio of 5.9. The stock has good growth prospects but is expensively priced. Avoid it.

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