Wockhardt: Further correction not ruled out

The decline in share price can be attributed to market expectations of a quick resolution to US FDA issues, which analysts weren't factoring in

The fact that Wockhardt recalled several batches of products from the US market spooked the Street, leading to a sharp fall in the company’s share price. Under US Food and Drug Administration (FDA) scanner since November 2013, the company saw its stock lose 27 per cent in the past three trading sessions, closing at Rs 1,243.35 on Tuesday, down 6.5 per cent, following the announcement of the product recall.

“As a measure of preparedness and as an abundant precaution, the company has decided to recall, as part of a remedial measure, all the remaining batches in the US market that were manufactured prior to the US FDA import alerts, though there is no evidence of risk to patient safety from the products currently available in the US market,” Wockhardt said in a statement.

The key reason behind the recent fall is unlike most analysts, the market had factored in a much quicker resolution to the US FDA issues and had expected resumption of exports from the Chikalthana and Waluj plants to start soon. As a result, the stock had rallied from Rs 550 levels in July last year to its 52-week high of Rs 2,000 early this month.

The sentiment had started improving visibly since December 2014, with the Chikalthana plant securing the approval of the UK Regulatory Authority for supplies to the UK. The management had said it had opened all its facilities to inspection by the US FDA, following the implementation of the desired GMP (good manufacturing practices) remediation in October 2014. These included the new Shendra facility, at MIDC in Aurangabad, apart from the Chikalthana and Waluj facilities, which had recorded observations by the US FDA, leading to an import alert in November 2013.

After inspection by the US FDA, the company had stated there were no findings related to data security and control measures implemented by it at the laboratory at Chikalthana. Following this, prospects of the unit securing a quick clearance increased and its share price rose.

Analysts, however, weren’t expecting a very early resolution. Last month, analysts at Macquarie said while the early Chikalthana laboratory facility inspection was a positive, the timeline for its clearance was the key. This, they believed, was a few quarters away. They had not considered major contributions from the facility till FY17-end, though they said resolution of issues by the company by FY16-end would boost earnings. Thus, assuming $70 million of incremental sales from the Shendra plant and a few launches through site transfer to a third party from early FY17 and without any contribution from the Chikalthana laboratory and the Waluj plant, they had arrived at earnings per share (EPS) of Rs 85 and a target price of Rs 1,700 for the stock. But in the absence of incremental sales, the

EPS was pegged at Rs 65, which meant a lower target price. In this backdrop, it was evident the stock had run up beyond fundamentals and a correction was bound to be seen.

The market is likely to watch developments on the clearance of plants by the US FDA, which will provide a trigger to Wockhardt’s earnings and fundamentals. The best-case scenario is the company’s Chikalthana laboratory being cleared by the end of FY16. Assuming the company is able to recover 40-50 per cent of the sales lost from this laboratory in FY17 (peak sales of $250 million earlier), it will generate $100-125 million of incremental sales in the US, resulting in an estimated EPS of Rs 125 in FY17, given the existing operating leverage, say analysts. This will translate into potential value of Rs 2,500 for the stock, say analysts. Given the run-up in the past six months, the stock could see further correction in the near term.