May 12 (SeeNews) - S&P Global Ratings said that it has affirmed the 'BB' long-term issuer credit rating on Bulgarian drug maker Huvepharma and revised its outlook to stable from positive.
Huvepharma under-achieved S&P's base-case scenario in 2019, recording slower-than-expected returns on investment and some profitability erosion, the ratings agency said in a statement on Monday.
S&P Global Ratings also said in its statement:
"Huvepharma embarked on a strategic investment phase comprising a new fermentation facility in Peshtera and new production unit in Razgrad. This saw capital expenditure (capex) increase to €131 million in 2019 and €103 million in 2018, from €61 million in 2017. The Peshtera project was completed by year-end 2019, after being initially slated for June. Similarly, the new production unit in Razgrad should be fully operational by the end of second-half 2021, after being initially expected at year-end 2019. The group's profitability deteriorated in 2019 despite strong revenue growth of 12.9% to €548 million. S&P Global Ratings-adjusted EBITDA remained stable at €121.6 million and consequently S&P Global Ratings-adjusted EBITDA margin reduced. This was the result of higher operational expenses due to external active pharmaceutical ingredient (API) sourcing, some restructuring costs related to recent acquisitions, and aggressive enzyme pricing from competition. The latter reflects that the group can be subject to pricing pressure due to the commoditized nature of part of its products, but management believes that price cuts have already been absorbed and does not anticipate additional pressure.
We remain confident that strategic investments will translate into profitable growth. Historically, the group benefited from its vertical integration as an API producer. However, over the years and with increased growth, it has had to source a more meaningful portion of APIs externally in order to meet demand from customers. With the completion of investment projects, including a 50% increase in fermentation capacity, the group can now meet at least 90% of its API needs, which we believe should materially reduce costs and support profitability improvement. Furthermore, we understand that Huvepharma will be supplying other players in the animal pharmaceutical industry at good levels of profitability. We note that the shortage in the global API market a few years ago (by year-end 2017) followed the Chinese government's decision to implement more stringent environmental requirements. This saw many players reduce production and others close down, leading to increased API prices. Huvepharma's EBITDA margin should also be supported by a more favorable business mix thanks to increased sales of highly profitable products such as Moninsin, Monimax, and OptiPhos and portfolio rationalization following recent acquisitions including Agrilabs (closed Jan. 5, 2018) in the U.S. and Qalian (closed Sept. 5, 2018) in France.
We believe that Huvepharma has a reasonable pipeline of products, but approvals could be delayed. Huvepharma's products include feed additives such as Monimax, OptiPhos Plus, and Ractopamine; anti-inflammatory products such as generics of Ketoprofen and Meloxicam; and a portfolio of vaccines. The latter is a more complex segment where the group has no established presence at this stage. In recent years, Huvepharma's performance in the U.S. was below budget due to increased scrutiny on ionophores and antibiotics usage. Globally, the group has gained market share in this segment following the exit of larger players. We note that in 2019 Huvepharma obtained Food and Drug Administration (FDA) approval for Monovet in the U.S. and it plans to very gradually gain market share in the country's cattle market. The approval is an important milestone, but the group will have to obtain additional approvals to succeed. This is because bundled offerings will contribute to market share gains.
We believe Huvepharma is positioned in a favorable end market, with solid demand and lower risks compared with the human pharmaceutical industry. Despite limited patents, we believe the animal health industry bears less risk because of the very long life cycle of products, much more limited investments in research and development (R&D), and the absence of patent cliffs. Furthermore, the global animal health market, excluding the companion animal segment should continue to expand. Although new product launches remain important, the nature of the industry puts somewhat less pressure on small players to get steady streams of approvals.
We believe that the COVID-19 pandemic should have minimal effects on the company and will not reduce growth prospects. The companion animal market will be affected by COVID-19 as visits to veterinary practices are constrained by lockdowns. Huvepharma is not present in this segment and 92% of its production is linked to the food chain, which we believe should remain resilient overall despite some challenges--as recently experienced by U.S. meat processing companies in their factories. Furthermore, we have no concerns regarding the supply chain as Huvepharma is vertically integrated and has internally secured production. We believe the effects should remain very limited and could mainly translate into additional distribution costs. The group's first-quarter results are encouraging, with revenue growth of 14% to €144.7 million compared with €127 million for the same period of 2019, and improving EBITDA margin.
We acknowledge scrutiny of antibiotics usage in the animal market and management's stance on the issue. An important portion of Huvepharma's sales stems from ionophores and antibiotics. Management argues against the use of these antibiotics for preventive purposes but only as a treatment in necessary situations. This is because unnecessary use of antibiotics' reduce their efficacy. Instead, management sees enzymes and probiotics as an indirect antibiotics replacement for preventive usage.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings. As the situation evolves, we will update our assumptions and estimates accordingly
The stable outlook reflects our view that the company will demonstrate strong revenue growth while progressively improving its EBITDA margin. This should translate into adjusted debt to EBITDA decreasing toward 3x. The stable outlook also reflects our assumption of positive free operating cash flow (FOCF).
We would downgrade Huvepharma if it fails to reduce its adjusted debt to EBITDA toward 3x in 2020. This could happen due to lower-than-expected demand or the absence of profitability improvement.
We could also take a negative rating action if FOCF remained negative or there was heightened refinancing risk because the company did not refinance its debt in the coming months.
We would take a positive rating action if Huvepharma increased its S&P Global Ratings-adjusted EBITDA margin toward 27% and demonstrated its ability and commitment to sustain S&P Global Ratings-adjusted debt to EBITDA comfortably at 2.0x-2.5x while generating FOCF approaching €100 million per year."