Under the microscope:
Aspen Pharmacare has been one of the darlings of the JSE for many years. Since the release of the group’s annual results in September, however, the share price has declined by a whopping 45% – from R272 to R150. Although until two months ago the narrative around the stock was alluring, we felt at the time that the growth expectations built into the price were too high and thus offered an insufficient margin of safety. While this margin has now increased following the stock’s dramatic fall, in our view it’s not yet wide enough to include Aspen in our portfolios.
Aspen Pharmacare is the largest manufacturer and distributor of pharmaceutical products in Africa. Through acquisitions, the group has been transforming itself from a South African-centric branded, generic and over-the-counter drug company into a more specialised global pharmaceutical player. The Aspen business has two main segments, which each account for roughly half of total revenues:
- Therapeutics, which are specialised products consisting of anaesthetics, thrombosis medicines and high-potency cytotoxics. These are niche products with smaller markets and more complex manufacturing processes, and are usually sold to hospitals.
- Other commercial pharmaceuticals, consisting of regional brands – a variety of prescription and over-the-counter drugs that are key brands in their regions – and manufacturing. Sales of regional brands are concentrated in South Africa and Australia, with a focus on growth in emerging markets. Manufacturing sites are mainly in South Africa and developed Europe.
Focusing on complex manufacturing within niche markets provides Aspen with more protection from potential competitors, as markets are often not large enough and manufacturing too specialised to justify the required investment from generics players. Aspen has invested heavily in building and improving its manufacturing operations, and we’re expecting superior scale within its product lines to drive down the cost of production. As hospitals form a large part of the customer base for the therapeutic segment, certainty of supply is key and bringing more of the manufacturing in-house certainly helps mitigate this risk.
Aspen recently acquired anaesthetics and thrombosis medication businesses in China, with an experienced sales force that has key relationships within hospitals. The Chinese opportunity is very much hospital based. The tendering process focuses on quality ahead of price, and this should favour Aspen’s anaesthetics portfolio. As the cost of anaesthetics is tiny relative to the actual medical procedure (US$2 vs US$2 000), anaesthetists are unlikely to switch from their trusted brands – Aspen currently has around 30% of the Chinese market share in general anaesthesia. In the major cities, globally trusted brands are preferred over their local counterparts and Aspen’s ambitions to grow here are evident in the fact that a third of the group’s sales force is located in Asia.
Emerging markets offer opportunities, driven by developing healthcare systems and improved access to affordable care. Aspen’s regional brand products are more suited to emerging markets as consumers prefer branded generics (Aspen’s game) over their non-branded counterparts. Aspen has distribution across 150 countries, with a strong presence in emerging markets, built over the past decade. This platform is the group’s key competitive advantage in emerging markets.
While both China and other emerging markets are a major focus of Aspen’s growth strategy, these markets are also notoriously difficult places in which to execute successfully. China is a complex business environment with its own culture, regulations and commercial practices.
Emerging markets have a tendency to be volatile, with increased currency and political risks. Around 45% of Aspen’s current revenue comes from developed markets (mostly Western Europe). These markets have come under much pressure recently due to price referencing, generic and bio-similar entrants, and decreasing healthcare budgets inducing price cuts.
We’re keeping a close eye on Aspen for signs that its plans are working in its key market segments and for evidence of organic growth. While Aspen is certainly on our buying radar screen, we’re not convinced it is cheap enough yet. However, for those who already own shares in the group, we advise holding on at this stage.