DSIJ Mindshare

US FDA’s Alert On Wockhardt: Much Ado About Nothing?

Pharma giant Wockhardt has received a strong setback after the US FDA sounded an alert on its Waluj manufacturing facility, after which the stock was hammered by more than 25 per cent in just two trading sessions. The market, however, seems to be overreacting to these developments. Shrikant Akolkar tells us more.

One of the worst things to happen to any stock is for it to get hit by factors which are apparently serious but on deeper exploration seem to be routine. This happens chiefly due to investors’ knee-jerk reaction to news flows which creates humongous negativity around it. One company which has recently been hit by this syndrome is Wockhardt.

We had recommended Wockhardt in DSIJ Vol. 28, Issue # 9 (dated 21 April, 2013) in our cover story ‘Cherry Picking’. The scrip was severely hammered following the recent US FDA alert on its manufacturing facility located in Waluj, Aurangabad district of Maharashtra. In just two trading sessions alone (May 23 and 24, 2013) it lost more than 25 per cent in value. Currently, the stock is down 35 per cent from where we had recommended it. Investors who have acted on our advice would surely be jittery in the wake of such a slide in the stock’s price. What should their future course in this counter be? Should one sell and book losses or wait out the depression? Here are the answers that you would be looking out for.

To start with, the hammering of the stock was a knee-jerk reaction arising out of fears fuelled by a particular event. This fear was accentuated by many other factors that were external to the company. The principal factor among these was the developments in Ranbaxy earlier in the same week.

Ranbaxy, the pharma company now owned by Daichhi Sankyo, pleaded guilty before the United States Department of Justice on compliance related issues in two of its manufacturing facilities. This was in any case weighing heavily on pharma stocks. The alert on Wockhardt’s Waluj facility came immediately after this, and dampened the sentiment on the stock.

What is worth noting is that Ranbaxy had ignored earlier malpractices, the consequences of which it had to bear. Wockhardt, however, had invited the US FDA team to audit its new injectables unit at Waluj. This is what differentiates between the two companies.[PAGE BREAK]

US FDA alerts are not uncommon in the pharma sector. Companies like Dr Reddy’s Laboratories (DRL), Lupin, Aurobindo, Cadila Healthcare, etc. have all faced similar issues earlier and have also successfully addressed them. An alert may take anything between one to five years to resolve. Aurobindo Pharma and DRL reclaimed their facilities in just around one year from where the import alert was sounded, and hence, Wockhardt’s claims of being able to regain these facilities within one year appear reasonable.

Habil Khorakiwala, Chairman, Wockhardt threw some light on the US FDA audit. According to him, the Waluj manufacturing unit has three manufacturing units, two for injectables and an oral solid dosage unit (OSD). According to him, the OSD unit brings in revenues of USD 75 million while injectables units brings in USD 25 million. The injectables unit that the US FDA audited currently does not bring in any revenues from the US. This is the main anomaly in the US FDA audit. The US drug regulator has put an alert on the entire facility, which actually has three separate units. Khorakiwala said that the company will bring this to the notice of the US FDA shortly. Any positive development on this front would lead to reinstatement of the USD potential 75 million revenues for the company.

A noteworthy point is that the company has another US FDA-approved OSD manufacturing facility located near Aurangabad, where it would be able to shift the OSD production subject to regulator approval. In addition to this, the company has built a brand new manufacturing facility for injectables at Shendra, also near Aurangabad. This facility is awaiting an audit in July 2013. If the company gets both these approvals, it would be able to significantly recover the lost revenues within the next eight-nine months. Also, for all the major products that are manufactured out of the Waluj facility, the company holds an inventory of one-eight months, which would lower the impact of the alert.

According to a study conducted by us, Wockhardt will any which way report a revenue growth of eight-nine per cent to touch Rs 6087 crore in FY14 and its net profit would come in at Rs 1622 crore. This is after adjusting the entire USD 100 million from its topline (which is the likely revenue loss following this development) and also after having adjusted for the probable two per cent loss in margins.

At its CMP of Rs 1297, the stock is available at 8.7x its FY14 forward EPS of Rs 148 (based of the profits earned as stated above). Being a large-cap stock, Wockhardt should trade at a higher PE but we have discounted a portion of it considering the weak sentiment surrounding the stock for now. At a PE multiple of 14x, its 12-month target comes to around Rs 2072, up four per cent from recommended price. Nevertheless, investors can average their position in the counter, which is a bargain hunt at the moment.

From the current price of Rs 1297, the target price would give a return of around 59 per cent. Those who have bought this stock at higher prices should accumulate it at the current levels. The counter may witness some volatility, but investors with a long-term horizon should continue to hold the stock.

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