Investors, it seems, are difficult people to satisfy. Earlier this week when pharmaceutical company Aspen reported the R12-billion sale of its European thrombosis business, the share gained 7%, buoyed by relief as shareholders recognised the deal’s positive impact on corporate debt. Two days later, when management reported positive full-year results to the market, the share fell by 5.5%, ending the day on R132.06. 

What was it that shareholders did not like?

On the face of it, the results were quite strong, given the juggling act that Aspen managed as the pandemic moved through its territories.

In China, the hard lockdown restricted the sale of medicines there for at least three months; Europe saw an increase in demand for products required to treat Covid-19 patients, but a decline in orders for products related to elective surgeries. And while South Africa, Australia and Mexico saw a spike in demand for certain products in the first wave of the pandemic, this was also followed by a predictable drop in demand for products related to elective surgery.

The end result was that group revenue increased 9% to R38.6-billion and normalised earnings before accounting treatments increased 7% to R11-billion for the 12 months ended 30 June 2020.

The increase in revenue was supported by growth from Commercial Pharmaceuticals (+6%), despite the difficult trading conditions, and Manufacturing (+22%). Normalised headline earnings per share increased 9% to R14.65, supported by lower financing costs.

“Management delivered on their promises in two important areas — debt and growth,” says Izak van Niekerk, an investment analyst with Mergence Investment Managers. “Debt has been reduced to comfortable levels, while headline earnings growth is higher than promised, which should reassure the market that Aspen is able to grow earnings again.” 

Following the disposal of assets, the foundations of the company have been reshaped with Aspen’s Commercial Pharmaceuticals business (which includes its Regional Brands and Sterile Focus Brands) weighted towards territories where it has demonstrated capabilities and a strong performance record, largely in emerging markets, says CEO Stephen Saad. 

Aspen’s pot of gold

A higher proportion of the business will be exposed to the private sector and will be better positioned to benefit from the expanding middle classes in these markets, he says.

So why did the share not rerate?

“Management has done what they promised, and the company looks in a position to grow, so we are puzzled by the fact that the market is still not satisfied,” says Van Niekerk.

Is it possible that investors were spooked by management’s suggestion that with debt levels reducing to manageable levels, Aspen will once again be in a position to make acquisitions? After all, it was the combination of expensive acquisitions without the commensurate growth in earnings that got the company into the pickle in the first place. 

While management is showing only slight interest in acquisitions at the moment, finding deals that are priced correctly won’t be easy. 

“Past deals were value accretive because Aspen traded at a high multiple and could do deals that were priced at lower multiples. But Aspen now has a price to earnings ratio in the single digits and you will not easily find pharmaceutical assets that are priced at 9x earnings,” Van Niekerk says.

If management believes the share is offering value at these levels, a better option would be for them to invest in buying back their own shares, he adds.

Priced as it is, Aspen is arguably offering value and a patient investor might be willing to give the company and its management time to prove that its new foundation can deliver growth. 

But there are a few flags to watch out for. 

One is the restatement of the 2019 numbers which Aspen says “provides illustrative comparability with the current period’s reported performance by adjusting the estimated effect of source currency movements”.

This may be so, but South African investors have become leery of management teams that constantly restate their reported numbers. 

Another number to watch in future is growth — in revenue and earnings. Growth has been disappointing in the past — turnover in the 2017 financial year was R41.2-billion while turnover for 2020 is lower at R38.7-billion — despite the fact that the rand weakened from about R13.50 to R16.00 between FY2017 and FY2020, roughly 19%.

Of course, the asset disposals over the past 18-months will have impacted on both turnover and earnings. But with these troublesome businesses out of the way, it is all the more reason to expect growth to accelerate. 

The company is now firmly focused on its “key foundation territories” of Africa, Australia, China and Latam. However, growth cannot be taken for granted in these regions. Apart from China which is growing, Africa and Latam are regions that are facing serious economic (and currency) pressure. And while China is growing, making money in this giant country has never been a picnic. 

Last, Aspen’s return on equity, once in the high teens, is now less than 7%. This is not unexpected given the enormous capital expenditure of the past few years, but this comes to an end in 2021. 

Aspen now has manufacturing facilities that will be the envy of pharma companies around the world — but they need the orders to fill them up.

In this regard Covid-19 has delivered one or two unexpected benefits: countries are now more circumspect about relying entirely on India and China for the delivery of vital drugs and will be looking to diversify their supply chains. And at the height of the pandemic in Europe, Aspen received calls from European leaders who wanted to ensure a consistent supply of life-saving drugs. By all accounts, the company came through for them and the Aspen brand was burnished in the process.

Management, led by Saad and Attridge, sound fired up to deliver on a new raft of promises and shareholders will be watching. DM/BM