Cadila Healthcare: The right remedy - Buy

The stock of pharma major Cadila Healthcare has corrected by over 20 per cent in the last five months. This was largely due to regulatory action by the US Food and Drug Administration (FDA) at two of its plants. In December 2015, the US FDA issued warning letter to its formulation facility located at Moraiya (Gujarat) and Zyfine active pharmaceutical ingredient facility (API) at Ahmedabad.

The regulatory tangle at the Moraiya facility is a dampener, given that supplies from there account for 60 per cent of the company’s US business.

That said, the company has commenced efforts to minimise the impact of this move. The large pipeline of drugs awaiting approval from the US FDA should rev up Cadila’s revenues over the next two years. At the current price, the stock trades at about 21 times its 2017-18 earnings. This implies about 20 per cent discount to the BSE Healthcare Index. Investors with a two to three year investment horizon can buy the stock.

The US accounts for about half of Cadila’s consolidated revenue. Of this, the Moraiya facility accounts for about 60 per cent. Also, over 40 per cent of the 168 drugs pending approval for the US market have been filed from this facility.

The US FDA after inspecting the facility in September 2014 had issued a few observations. This related to batch failure of blood thinner drug Warfarin and handling of market complaints and investigations.

In December 2015, the US FDA issued a warning letter to this facility. This is a dampener, given that the regulatory action will delay approval for products filed from this facility.

However, the company has undertaken two initiatives which provide some comfort. One, it is already working with external consultants to revise the standard operating procedures. It has stopped manufacturing the drug under question and plans to reformulate it. Second, the company is believed to have initiated transfer of select key products filed from this facility to Baddi (Himachal Pradesh) and the SEZ facility in Ahmedabad.

This includes exclusive/limited competition drugs such as the generic version of ulcerative colitis drug Asacol HD and gastrointestinal drug Prevacid.

Besides, the company has set up a special group to closely track global FDA action to ensure regulatory compliance proactively. The company has also put in place a Laboratory Information Management system for online recording of all the analysis undertaken at the plant.

The revenue contribution from the API (Zyfine) facility at Ahmedabad, which is also under the regulatory scanner, is negligible. The company has withdrawn filings made from this plant and temporarily supended operations there. While the company seeks to achieve full compliance in the long term, it has temporarily de-listed the facility from the FDA register. Despite this being an oncology API facility, Cadila does not see impact on its oncology formulations business as it already has a second source for most of the APIs.

Initiatives to minimise impact at the Moraiya facility through site transfers should help. Approval for products filed from the Baddi and Ahmedabad SEZ facility should add to revenues over the next 12 months.

Besides, Cadila’s scale up in other key markets such as India (31 per cent of consolidated revenue for the nine months ended December 2015) should support growth in the near term.

The company has launched about 12 products in India in the December quarter; this includes biologic drug Vivitra to cure breast cancer and anti-diabetic brand Tenglyn. It expects to sustain the pace of launches.

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