Article from Money Web
In need of an injection.
Being a pharmaceutical company just about anywhere in the world is tough. With healthcare being both a critical and emotional issue, government regulation of the industry is onerous, and public expectation is high.
Yet, despite this, big pharma is big business. And the reason for that is pretty simple: people will always get sick. The demand for medicines is therefore ever-present, and it is growing along with the increasing global population and expanding wealth of developing countries.
For more than a hundred years, Adcock Ingram (JSE:AIP) has been meeting a large part of this demand in South Africa. It is comfortably the oldest pharmaceutical company listed on the JSE and has an entrenched position in the country.
The question many analysts are asking, however, is whether it can take this success elsewhere.
“They've been talking for quite some time about expansion opportunities, both in Africa and globally,” says Neil Stuart-Findlay, fund manager at Investec Asset Management. “It's becoming more difficult for them to grow meaningfully in the local environment, and any significant international expansion is likely to be acquisition driven. The question is whether they can do this without such a deal being dilutive for shareholders.”
Adcock Ingram's brands include over-the-counter products such as Panado, Corenza C, Compral, and Cepacol; homecare ranges such as Doom, Airoma and ICU; and the TLC personal care portfolio. It is a market leader in tonics, priobiotics and supplements where its brands included Bioplus, vita-thion, ProbiFlora, ViralGuard and Bestum, and also sells hospital equipment and diagnostic products. It is a major supplier of anti-retrovirals and HIV test kits in South Africa, and markets an extensive range of generics and branded products, many under license from multinationals such as Roche, Novartis, Merck & Co, Eli Lilly and Baxter.
History
In the early 1900s, a young man by the name of Hyme Tannenbaum took a job at the EJ Adcock Pharmacy in Ockerse Street in Krugersdorp. He subsequently encouraged his three brothers – Jack, Len and Archie – to join him there.
Within a few years the brothers bought the pharmacy and made a decision to look for ways to expand their business. To do so they bought out a number of existing pharmacies between Johannesburg and Carltonville, and set up a few new ones of their own. One of the pharmacies they took over was the Fred Ingram Pharmacy in Hillbrow, which in 1937 gave birth to Ingram's Camphor Cream.
During World War II the Tannenbaum brothers were joined by a Hungarian chemist evading the Nazi occupiers in his home country. He convinced them to set up the first pharmaceutical manufacturing facility in South Africa, which became operational in 1940.
The facility was an immediate success and Adcock Ingram acquired the rights to manufacture certain products under license from the US pharmaceutical giant Baxter in 1948. It listed on the JSE two years later.
In 1978 the Tannenbaum family sold their shareholding in Adcock Ingram to Tiger Oats Limited (which later became Tiger Brands). This gave Tiger a majority shareholding in the company.
Adcock Ingram merged with Premier Pharmaceuticals in 1996, creating South Africa's largest supplier of healthcare products at the time. In 1999 the company's bid to acquire South African Druggists was rejected by the competition commission, ultimately allowing Aspen Pharmacare to take over that business.
Tiger Brands bought the remaining shares of Adcock Ingram in 2000 and delisted it from the stock exchange. However, the company was unbundled and relisted in 2008.
Dividends
For the 2011 financial year, Adcock Ingram declared an annual distribution (in the form of capital reduction out of share premiums) of 187 cents per share. This was marginally up from the 180 cents per share distributed in 2010. For 2009, the group paid out 150 cents per share.
The counter offers a yield close to 3.0%.
Which funds hold this stock?
Adcock Ingram enjoys an interesting profile amongst South Africa's leading unit trusts over the last three to five years. All three of the top-performing value funds over that period include it in their portfolios. The Nedgroup Investments Value Fund gives the counter a weighting of 4.3%, the Momentum Value Fund 3.3%, and the Prudential Dividend Maximiser Fund 1.7%.
It does not, however, feature in any of the three leading equity industrial funds.
Of the six leading general equity funds, two have Adcock Ingram as a top 10 holding. Both the Absa Select Equity Fund and the Prudential Equity Fund assign 3.2% of their portfolios to the counter. However, none of the other four funds has exposure to the stock at all.
To see which funds are buying and selling the counter, visit Moneyweb's Unit Trust Portfolio Tool.
Why would an individual consider investing in this company?
In South Africa, Adcock Ingram has an established market position in a number of sectors. Its diversified portfolio gives the group a number of revenue streams not solely reliant on pharmaceuticals. It has exposure to the fast-moving consumer goods market, and also has a strong medical devices business through which it sells products manufactured by principles such as Becton Dickinson and ABX.
Government initiatives across sub-Saharan Africa to fight HIV/AIDS have also created a high demand for anti-retrovirals, which Adock Ingram is well positioned to meet. It is represented in Southern Africa, East Africa and West Africa, and has manufacturing capabilities in South Africa, Zimbabwe and Ghana.
In addition, through its strategic alliances with a number of multinationals the group has diversified its revenue streams and gained additional platforms for growth on the African continent. These marketing and distribution agreements allow it to sell branded products, using the expertise is has gained in South Africa.
The stock also enjoys a position as a defensive counter due to the nature of its business. Furthermore, the group's strong balance sheet, based on its good cash generation, puts in in a position to pursue growth opportunities both through acquisition and capital expansion.
What risks does this company face?
Ever since Adcock Ingram failed in its bid to acquire Cipla Medpro South Africa in 2009, the group has faced questions about what it intends to do with its excess cash. It has not made any major acquisitions, despite talking for a long time about its ambitions to grow both in Africa and globally.
“On the one hand it's been encouraging from a shareholder perspective that they're looking for the right target and have shown that they are not willing to overpay for it,” says Investec Asset Management's Stuart-Findlay. “However, there's no doubt that they are constrained by the South African environment.”
Adcock Ingram's local troubles include the disappointment of receiving just 4% of the latest government tender for anti-retrovirals. It was expecting a larger award, given that it received 21% of the last tender, and will be working at ensuring that it receives a larger slice of the pie in the next round. This is an important part of its business and it can't afford to lose further ground to its competitors.
Last year Adcock Ingram was also forced to stop selling some of its best-selling products after the Medicines Control Council (MCC) withdrew their registration. The MCC ruled that analgesic drugs such as Synap Forte had to be withdrawn due to safety reasons.
The drugs contain the agent DPP, which the FDA in the USA believes to be unsafe. In total, these medicines are worth around R200m a year in sales to Adcock Ingram and not being able to market them will put a dent in their earnings. The group is however appealing the ruling, and believes that independent clinical trials show the products to be safe.
“Those two issues certainly put a dampener on their growth prospects in the short term,” Stuart-Findlay believes.
The company is also facing pressure from government's decision to only increase the Single Exit Price (SEP) by 2.14% for 2012, after no increase was granted last year. The SEP regime determines at what price manufacturers may sell certain medicines, effectively capping margins on those products.
However, inflationary pressures such as labour and electricity costs are cutting into the profitability of manufacturers. The weaker rand over the last year has also pushed up the prices of active ingredients, most of which have to be imported.
“Although it doesn't apply to all of their products, Adcock Ingram already has limited pricing power because of the SEP,” Stuart-Findlay says. “So the recent limited SEP prince increase does curb the amount of top-line growth they can achieve.”
Where does this company’s growth potential lie?
It may be surprising, but Adcock Ingram believes that one of the things it has the most reason to feel optimistic about is the proposed National Health Insurance (NHI) scheme in South Africa. The group believes that the NHI's goals of serving more people, more effectively, will create additional demand for medicines.
In particular, the expected increase in the requirements for cheaper generic drugs will benefit a local manufacturer that is able to produce them cost-effectively. Adcock Ingram is already the second biggest supplier of generics to the South African market, and there may well be opportunities for them to grow their market share through the NHI.
Beyond that, however, Adock Ingram's growth prospects in South Africa seem quite limited.
“Historically, they have strong market share and a fairly established product range in the domestic market,” Stuart-Findlay explains. “However, going forward, their product pipeline appears fairly limited, which could make the operating environment far more challenging.”
The group is therefore looking to expand its operations outside of South Africa through acquisitions, organic growth and increasing its partnerships with multinationals. It has already established operations in Ghana and Kenya, which it hopes to use as a springboard into surrounding territories.
In a number of African countries the time it takes to get approval for the registration of a drug is quicker than in South Africa, and the group aims to have registered 500 products in West and East Africa by 2015. Although these markets are still relatively small, if Adcock Ingram is able to supply its medicines at affordable prices, the long-term market opportunity is potentially large.
In addition, the company is looking at the possibility of marketing certain products in India where it already has a manufacturing facility. However, this is a tricky market in which to gain a meaningful foothold.
“From a pricing perspective, if you look at the multiples that generic companies are trading on in that country, it's quite difficult for them to make an acquisition that's not dilutive,” Stuart-Findlay says. “It's also a big step in terms of a new geography with its own set of regulatory challenges.”
For more, visit Moneyweb's click-a-company profile on Adcock Ingram Holdings Ltd.
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