Aspen Pharmacare is the largest manufacturer and distributor of pharmaceutical products in Africa. It was traditionally a branded, generic over-the-counter pharmaceutical company operating mainly in South Africa and Australia, but over the past eight years, the group has transitioned into a specialty global pharmaceutical company focused more on complex manufacturing.
Aspen’s business can be divided into three parts:
- Regional Brands, which accounts for nearly half of group revenue. This division encompasses hundreds of categories across both prescription and over-the-counter medicine. Although it has operations across many countries, most of the revenue comes from Africa and the Middle East, and Australasia.
- Sterile Brands accounts for a little over a quarter of Aspen’s sales. Typically used in acute hospital settings, the wide array of products includes niche anaesthetics and thrombosis therapies. This business operates mostly in Asia and Europe.
- Manufacturing also makes up just over a quarter of the group, with multiple facilities around the world. Products range from sterile vaccine vials and syringes to simple pills and active pharmaceutical ingredients.
While we avoided Aspen on valuation grounds for many years, the share price decline during 2018 and 2019, and the expected risk/reward balance we saw going forward, significantly increased the group’s investment appeal, and we therefore included the share in our portfolios in October 2019.
Although we took some profits and reduced our stake in Aspen very close to the highs of September 2021 when the market became almost euphoric about Covid-19 vaccine potential, we have remained overweight in the name.
INVESTMENT CASE
Apart from the attractive price, our original investment case centred on three factors:
- The shift in the group’s focus from low-moat generics distribution towards more specialised niche products
- The long-lead-time investment in sterile manufacturing capacity, much of which will be used for standard children’s vaccines in Africa (including those for meningitis and rotavirus)
- The expected major reduction in debt as Aspen improved its balance sheet.
Looking back since then, the group has achieved the second and third points above admirably, while the first point was partially negated by the sale of some of the thrombosis medicine business.
When we purchased Aspen in 2019, it had R85 per share of debt on the balance sheet, or 3.6 times earnings before interest, tax, depreciation and amortisation (EBITDA). We now expect the group to report net debt of only R25 per share, or 1.0 times EBITDA, in its June 2023 results. Around R38 per share of the debt reduction has come from the net disposals of businesses, with the rest coming from operating cash flows.
EXPANDING THE ASSET BASE
Over the 3.5-year period since October 2019, Aspen has also invested a further R22 per share in expanding its asset base. It is this spend, much of it on sterile manufacturing capacity, that has facilitated the market’s recent excitement about the group’s prospects and has driven the 38% rise in the share price so far in 2023 (at the time of writing).
Sterile manufacturing plants take time to build and certify and only once this process has been completed is a company able to begin the often-lengthy process of winning customers to fill the available capacity. There is high operating leverage associated with filling such sterile facilities and Aspen recently reported that it has made major progress in contract negotiations. The group now expects to increase its capital investment to meet demand.
With the spend on sterile manufacturing set to bear fruit over the coming years, Aspen’s earnings growth profile appears attractive. From a June 2023 base, our modelling points to around 15% annualised growth in earnings over the next three years. Such growth, should it be achieved, justifies a further re-rating of the earnings multiple on which the stock trades, from the current price-earnings multiple of around 10.5 times to around 12 times.
AMPLE SCOPE FOR SUCCESS
While much of our original investment thesis has already played out, in our view there is still ample scope for the Aspen story to continue. The group is emerging from its multi-year transition period as a stronger business, with wider moats and a more attractive product mix. On top of the expected growth, its balance sheet has sufficient capacity for further deployment of capital to drive additional growth vectors. Given the above, we remain comfortable holders of the shares in our client portfolios.
