Aspen Holdings, a pharmaceutical company listed on the JSE reported their interim results on Friday. The share price has already lost two thirds of its value since hitting an all-time peak in 2015. Never the less, while Stephen Saad presented the results to analysts and investors, the share price plunged intra-day by a further 50%, ending the day 28% lower. Did the performance really warrant such a drastic move? Or is something else at play?
There was much not to like about Aspens recent results. The headlines point to a worrying picture for a once fast-growing company; net revenue increased by only 1%, EBITDA was down 3%, headline earnings per share were down 9%, and free cash flow per share down by 45%. The borrowings increased drastically from R46bl to R53bl, the cash conversion rate is at an unusual low of only 47%. These are troubling numbers for Aspen shareholders, who are used to see growth in the double digits. Some clearly scrabbled to exit their position, accepting a 50% lower price than the previous day, fearing that in hindsight, that decision might still be a good deal. And all this without going through the details of the presentation.
Aspen used to be the darling of the JSE. Lead by the very entrepreneurial Stephen Saad, Gus Attridge and their team, they grew the company from nowhere in the late 90’s to one of the leading pharma companies in the emerging markets. The company was easy to understand. They produced generic medicine, owned a few over-the-counter brands, manufactured products like eye drops for third parties and distributed branded prescription drugs from GSK. The constant exploration of new opportunities led them to grow internationally, especially in Australia and the emerging markets. The business model stayed the same. The key was to open channels of distribution and then pass through an array of products, from their own generics to branded prescription drugs. They were very successful, which reflected in the Aspen share price. In 2015 it hit a peak of more than R420 per share, trading on a price/earnings multiple of more than 35.
But that’s where the strategy changed slightly. Aspen bought a struggling French manufacturing facility in Notre Dame de Bondeville. It provided a great opportunity to change focus from the increasing price sensitive generics medicine markets to sterile focused brands, primarily producing anesthetics and thrombosis drugs. These are much harder to produce, since the quality consistency is so critical. Aspen needed to invest a lot of capital to increase the capacity to produce at a volume level where they can guarantee uninterrupted supply. That investment is still ongoing, just as the investment to upgrade and increase their production capabilities in South Africa and Germany. The full effect of the increased production capacities will only be seen over the next three years, but to achieve higher volumes one would need to spend a lot of costs upfront. Hence also the higher debt levels.
Besides the big increase in debt, a major concern investor have is that much of the debt is denominated in Euro’s. Given that in their most recent results 38% of their revenue is from the Euro area, this should hardly be surprising. A prudent manager should always match the assets with the liabilities.
Investors are also worried about the delay of the sale of the nutritional business, and the sale itself. They are worried that Aspen is selling their crown jewels to finance their new acquisitions. First the delay of the sale itself. The sale was originally to be concluded within 6 months, and ambitious task given that it is a multinational business. This will now be concluded at the end of May. But the answer to the second question might also give an indication on why the share price has been performing so poorly. Yes, Aspen has done very well out of the nutritional business. But the sale is just the nature of the beast. Aspen is constantly morphing into an increasingly sophisticated business. As they see opportunities that fit with their future strategy, they are not scared at making big commitments. If investors buy Aspen shares they buy into the managements ability to spot opportunities in the Pharmaceutical Industry and extract as much value as possible from it. It is very hard to value such abilities, and it gets increasingly harder as the products become more complicated and niche. It also becomes more difficult for mr Saad to sell the good story to investors, as there are more and more moving parts, each of which are difficult to value. Added to that, the investor must look 3 to 4 years ahead to see the results of their current strategy. That is a hard task for those who, at best, are concerned about the next 6 months. It is anyways easier to follow the crowd instead of dissecting the complicated financial statements.
So what is my take on Aspen shares? I hold Aspen shares and have been holding them for ever. For a long time, I didn’t add any, but with the recent price movement I have. I don’t have a target price, because that would just be an arbitrary number. Instead I focus on 3 point: the managements ability to execute, the downside risk to the current concerns and the managements own skin in the game.
Firstly, they have a very good track record. Even though they did get a few things wrong along the way, like their investment into Venezuela, they got most right. The crucial part is that their ability to manufacture products at the highest international standard, which has been proven repeatedly.
Secondly, the downside risk. Their cash on hand covers their current liabilities payment obligations, which secures them for at least a year. The right time to gear up the balance sheet would be when interest rates are at a historic low. The time seems right to do exactly that. The crucial question is what covenants and what durations the loan agreements have. At an interest cover of 5.6 times and a net debt/ebitda of 3.7 (calculated after the conclusion of the sale of the nutritional business) they don’t seem to be in any immediate danger. The proceeds from the sale of the nutritional business will reduce their debt by 18%.
Another important point to remember is that the new accounting standards also don’t allow them to increase the value of any investments they have made (they can only write them down). That means that if they spot an opportunity where they can create value, that value is never reflected in the balance sheet until the business is sold again. Therefor their balance sheet would always be understated. Given that shares NAV is about R110, any price around that surely presents value. Added to that, on a historic P/E multiple of 7.5, even a company with pedestrian growth looks attractive.
This brings us to the third point: managements skin in the game. Two of the three biggest shareholders are Stephen Saad and Gus Attridge. They were happy to buy more shares in October 2018 at a price just above R155. Mr Saad bought for 93 million Rands worth, and mr Attridge for 15 million Rands. If they were happy to buy shares at R150, surely R110 seems like a bargain?