Geopolitical tensions, inflation see Aspen’s interim profit down

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FIFI PETERS: Shares of Aspen, the best-performing stock on the JSE today, were getting a lot of positive doses of investor interest after the release of its first-half results. But it was all about the guidance, the guidance that Aspen gave its investors that the second half would be a whole lot stronger, and that it expected a much bigger contribution than it initially forecast from filling up the available space in its sterile-manufacturing business. That is in Gqeberha in the Eastern Cape, as well as in France.

I spoke to Sean Capazorio, the CFO of Aspen Pharmacare, and I asked what was behind the much-improved outlook that the company delivered to the market today. Here’s what he said.

SEAN CAPAZORIO: We’ve been working very hard at trying to fill our capacity in Gqeberha, and that outlook covers our Gqeberha facility and our sterile facility in France. So the one facility, the facility in France, has pre-filled syringes, and the one in Gqeberha does sterile vaccines and other biologicals.

Subsequent to doing the Covid vaccine, that put us on the stage to showcase South Africa and particularly Aspen as a world-class manufacturer of steriles, and gave us the opportunity to discuss opportunities with other multinational partners.

I think we’ve now started to see the emphasis of all of those discussions and we’ve got some sort of contract-negotiation discussions with a number of partners now – and that’s given us the confidence to actually rerate the benefit that we would get from these facilities, because we put a lot of investment into them. They’re really high-fixed-cost facilities, as you can see from our first six-month results.

When you don’t have the volume in there, it has quite a profound impact on the margins going down. The corollary of that is when you get the volumes back in, you see clear exponential growth. I think with these opportunities that we are negotiating with some of the multinational partners we do see a big opportunity to grow the volumes and bring quality business into both of those sites.

So that’s given us the confidence, I think, to look at our capacity and sort of revalue it. We valued the value, total capacity, at R8 billion, and we targeted that by the end of calendar year 2024, where we’ll have filled half of that capacity benefit of R4 billion.

That really is the background. At the onset we were probably a little bit conservative, and we didn’t really know what the value was that we had invested in. Obviously subsequently we did the deal with the Serum Institute to get the licence, the vaccine that we can provide to the African continent.

Subsequent discussions have really shown that we have a quality facility in Gqeberha that can match any other sterile facility in the world.

The attraction for partners is that they’re able to get benefit from an ESG [environmental, social and governance] perspective as well, because we are providing them with patients with access to medicine. So they’re getting the benefit of patient access, quality and cost competitiveness. And for us we get the benefit of these volumes in our Gqeberha facility, and likewise in our French facility a big opportunity on pre-filled syringes.

So I know it’s a long answer to a short question, but that’s what’s given us the confidence to be able to put a little harder value to that capacity.

FIFI PETERS: Sure. The risks? Today we had some manufacturing data coming out, showing that sentiment in the sector was being hurt by the power cuts and the concerns that more aggressive power cuts would continue. We’ve heard that load shedding is likely to be with us for the next 12 to 18 months or so, depending on how effectively whichever solution on the table gets used. But what are the major risks for you?

SEAN CAPAZORIO: I think we obviously are a key site within the Eastern Cape. We are also classified as an essential service. With the vaccine supply we were classified as an essential services business.

So we do have an arrangement with the Nelson Bay municipality that we only get load shed from Stage 5 onwards, and in a controlled manner. So it’s not an ad hoc load shed. We do it in conjunction with the municipality, so we’re able to control it.

We then do have full backup systems – mainly diesel, some solar – to be able to provide power in those staged backup facilities.

And then on top of that, we’ve embarked on a project with a partner to recycle plastic, a process called pyrolysis. We convert the plastic into a gas, and that drives electricity.

So we plan over the next 18 to 24 months to be off the grid in Gqeberha and to be on a recyclable renewable-energy source.

But obviously in the short term we are at Stage 5 load shedding; it’s controlled and done in tandem with the municipality, so for us the risk is quite low.

However, we do acknowledge that it is a challenge for everyone in this country and it obviously affects all of our staff. So we do have sympathy and try to manage our people in the best way we can.

FIFI PETERS: Sean, you also guide, as I said in my initial question, that the second half of your reporting period will be pretty strong. The picture that we’re looking at right now in terms of how you fared this time around [is that] revenue was lower and profits also took quite a knock. What will be the kicker that improves the picture in the second half of the year, which you expect to be stronger than the second half of last year?

SEAN CAPAZORIO: Thanks for that question. I think the big kicker for the growth in the second half for this show is in our manufacturing business. There are two elements to that.

The one is our API [active pharmaceutical ingredients] chemicals business, which traditionally has a stronger second half. It had a one-month closure in the first half, so we do see quite a strong second-half coming from our API business.

And then we’ve done quite a lot of work in our sterile facilities in the first half, in getting ready to bring these new contracts, opportunities onto our lines. That takes 12 to 24 months plus, which is quite a long timeline to bring this type of technology in.

So we’ve sacrificed revenue-generating work for these technical transfers. That’s obviously all been sacrificed also in the first half.

In the second half we see our manufacturing businesses, particularly on the sterile side, getting back to normal output. That’s also a big driver of the second-half growth. The second half last year was heavily impacted by the Covid lockdown in China, etc, which also went through to the first six months of this year. As you know, China has [lifted] its restrictions on Covid. So we should see quite a good performance coming out of China in the second half in our commercial pharma business.

Some of our emerging markets do have a seasonally strong second half, so I think all of those factors combined have given us the confidence to project a good second-half performance, better than both H2 of last year and H1.

FIFI PETERS: On Covid-19 though, I see you say that the lack of sales or volumes around vaccines in the current reporting period impacted your profits this time around. What is the current activity around Covid now?

SEAN CAPAZORIO: The guidance that we gave last year – it’s amazing how quickly time flies – last year this time, in the last financial six months we were in full manufacturing momentum for Covid vaccine for J&J. So we had a full six months of Covid manufacture. Obviously if you fast forward to this six months that whole landscape has changed; the contract with J&J for that manufacture has now come to an end.

So for this six months you had one or two batches, but very little Covid manufacture in the six months. So you’re comparing a six-month period in the previous year, which was fully laden with Covid revenue, to one that has had no benefit.

That has also had an impact on our manufacturing modules. We’ve decided – because we are now dealing with these other contract deals, we’ve got this deal with Serum [Institute] – to keep all of those fixed costs on board because we’ve anticipated the volumes into the future. So we’ve kept those fixed costs, but we haven’t got the revenue, and that’s also impacted our performance on the manufacturing side in this half.

FIFI PETERS: Okay. So [Aspenovax] is no more.

SEAN CAPAZORIO: I think at this stage the next potential orders could be in 2024, but we haven’t got that anywhere in our plan. If there is a need for Aspenovax, we will certainly prioritise that above all other opportunities or a pandemic type of scenario. But at this stage we do not foresee any orders in the short term. And if we do get orders for boosters, it will only be when the stocks have run out – and that will be in 2024 onwards, potentially. But we don’t see big momentum at this stage.

FIFI PETERS: Okay. Just finishing off, the cost factor. Like many other companies in South Africa and all around the world, costs are climbing. You are seeing inflation in your business. What does this mean for the price of medicines and the like, what consumers should be expecting to pay in this environment? What is pharmaceutical inflation looking like?

SEAN CAPAZORIO: Yes, from a pharmaceutical perspective it depends on which markets you’re looking at.

In your developed markets you’ve got no room for any [higher] pricing. In your emerging markets you do get some sort of inflationary relief from government, but it’s still not sufficient.

So the only way you maintain your profitability within the Aspen environment is you have to drive down your costs and you improve your efficiencies and your factories, and also bring volume from third parties back into our own facilities.

We’ve managed to do that quite successfully – without heavily impacting pricing through to the consumer – to try and bring our cost of goods down in our facilities, and we’ve had a very good performance in the six months.

You’ll see our consumer margins have improved, and that’s predominantly as a result of some of those savings initiatives which have taken a long time to implement. And we’ve also had to battle against inflation in the background. So it’s really been a commendable performance, but certainly one that remains a challenge going forward. In pharmaceutical, because it’s price controlled, you’ve got to maintain your margins, you’ve got to watch your efficiencies and your costs.

FIFI PETERS: Sean, thanks so much for that time and giving us a lot more colour on your guidance and what we can expect from the business in the period ahead. Sean Capazorio is the CFO at Aspen Pharmacare.