India Ratings & Research (Ind-Ra) has upgraded Strides Arcolab (Strides) long-term issuer rating to 'A+' from 'BBB+' after resolving the Rating Watch Positive (RWP). The outlook is stable.
Commenting on the rationale, Ind-Ra said, "The resolution of RWP follows the completion of sale of Strides' 100% subsidiary Agila Specialities (Agila) to Mylan Inc and use of sale proceeds to pay off a significant portion of Strides' debt. Strides currently has a negative net debt position on account of debt repayment and a cash balance of USD 85 million. This has been retained as growth capital after a dividend distribution of USD 525 million out of the total sale proceeds of USD 1.75 billion.
The upgrade reflects elimination of earlier rating constraints. The level as well as structure of debt was a constraint, as bulk of the debt was either in India or guaranteed by the Indian parent whereas a large portion of the EBITDA was accruing outside India. Facilities in India as well as in Brazil either were still under construction or had just become operational. EBITDA margins were also weak and foreign currency convertible debentures had to be redeemed as the share price dipped below the conversion price. The rating was also constrained by the aggressive growth strategy of the company which included acquisitions.
With the cash from Agila sale now sitting in India and net debt turning negative, the structural issue is resolved. All the facilities of Strides are now functional and this resulted in its EBITDA margin improving significantly to 19.8% in 9MFY14 (nine months ended September 2013) from 11.2% in 2012. The company has also publicly declared that it does not have any new acquisition plans for the near term.
With the completion of the sale, Strides' high-margin business of injectables, operated from nine manufacturing facilities globally, will move to Mylan. Strides will continue to operate the pharma business (branded generics in India and Africa and IP-led generic formulations in the US) which recorded revenue of Rs 9.3 billion in 2012 (2011: Rs 7.2 billionn) with EBITDA of Rs 1.03 billion (Rs 1.5 billion) including licensing income. In 9MFY14, Strides reported revenue of Rs 7.1 billion and EBITDA of Rs 1.4 billion. Although the residual pharma business will continue to grow and be cash flow positive, substantial growth is likely to come from the new bio-similars business which is likely to start generating revenue in FY15.
Net financial leverage (adjusted debt net of cash/EBITDAR) for FY14 (15-month period ending March 2014) will improve and is estimated by the agency to be negative (FY14: negative 1.5x, 2012: 2.6x). Post FY14, Ind-Ra expects the net leverage to remain negative while any future capex will be funded through the growth capital.
Mylan has held back USD250m from the sales proceeds which will be released only after the resolution of the warning letter issued by the US FDA on one of Agila's Bangalore plants. Since Strides has already declared that this amount will also be distributed to shareholders, the final outcome of the resolution exercise or the amount paid will not have any bearing on the ratings.
Strides has also retained a contingency fund of USD 40 million to provide for any excess expenditure on the resolution of the warning letter as well as a USD 100 millio tax escrow to take care of any tax assessment related demands in different jurisdictions that the erstwhile Strides Arcolab Ltd operated in. The company expects the contingency fund to be released in 1HFY15 and the tax escrow to be released over the next four years. This will further strengthen Strides’ credit profile.
Strides' pharma business had 46 cumulative Abbreviated New Drug Application filings with 28 approvals as on November 2013. Moreover, Strides has a portfolio of over 300 products for its African market and in its Indian branded generics portfolio."
Shares of the company declined Rs 4.9, or 1.26%, to settle at Rs 383.35. The total volume of shares traded was 57,913 at the BSE (Friday).
