Fitch Rates Jubilant Pharma First-Time 'BB-'; Bond 'BB(EXP)'
The senior unsecured rating reflects provisions in the indenture for the proposed bond, which limits prior-ranking debt to levels commensurate with Fitch's guidelines for low structural subordination. The proposed notes are rated at the same level as JPL's senior unsecured rating because they constitute direct and senior unsecured obligations of the company. Noteholders will rely solely on JPL for repayment as the restricted subsidiaries will not be providing guarantees. The final rating is subject to the receipt of final documentation conforming to information already received.
KEY RATING DRIVERS
Weaker Consolidated Profile: JPL's IDR is based on its parent Jubilant Life Sciences Limited's (JLS) consolidated profile, given Fitch's assessment of moderate linkage between JPL and its parent, which Fitch assesses to have a weaker credit profile than its subsidiary. JLS's life science ingredients business has strong positions in some of products, such as pyridines, acetyls and niacinamide, and its backward integration gives it a cost advantage compared to some of its peers. However Fitch believes cash flows from the life science business are more vulnerable, given the commodity nature of products, intense competition and the inherent cyclicality of the business.
Proposed Bond Rated above IDR: JPL's bondholders will have direct recourse to JPL's cash flows and assets. The rating on the proposed bond is above the IDR to reflect reduced secured debt at JPL following the proposed bond issue and use of proceeds to refinance a portion of secured debt currently on JPL's balance sheet. Following this refinancing, we expect the ratio of JPL's secured and prior-ranking debt to EBITDA to reduce to below 2x. The indenture of the proposed bond restricts the amount of prior-ranking debt that JPL can have.
Robust Growth Prospects in Radiopharma: JPL's Draximage business is the fourth-largest participant by sales in the small North American nuclear imaging market. Draximage faces very limited competition for some of its top products, such as MAA, an albumin injectable used in lung imaging, and DTPA, a pentetate injectable used for brain and kidney imaging, both of which have no competitors at present. Draximage has expanded strongly in the last few years and is poised to grow further with a healthy pipeline of products.
JPL aims to launch Ruby Fill, an infuser device used for heart imaging, in the fourth quarter of the financial year ending 31 March 2017 (FY17), should the device be approved by the US Food and Drug Administration (USFDA). Ruby Fill has significant patient safety-related advantages over a competitor's existing alternative. Ruby Fill is the first new product due to be launched in this segment in nearly 25 years, and there are no known competitors. JPL estimates the market size for Ruby Fill at about USD70m.
Adequate Pipeline for Generics: JPL's generics formulations and active pharmaceutical ingredient (API) business is primarily focused on the key regulated markets of US and Europe, with adequate off-patent Abbreviated New Drug Application (ANDA) filings to counter competitive pressure on its existing portfolio. JPL has so far filed 73 ANDAs and 81 Drug Master Files (DMFs) in the US as at 30 June 2016, of which 46 ANDAs have been approved and 34 DMFs have been reviewed.
Healthy Orders for Contract Manufacturing: The contract manufacturing order book stood at USD534m as of 30 June 2016, or 6.4x of FY16 revenue in this segment, following the successful resolution of violations of USFDA standards at its contract manufacturing plants in 2014-2015. JPL's contract manufacturing (CMO) business mainly produces injectable and other sterile products for the North American markets. The business is driven by patented products (nearly 80% of sales), and customers, which are mainly large pharmaceutical companies, are primarily focused on quality standards rather than costs alone.
Regulatory Risk in Pharma: JPL and its peers face regulatory risks associated with non-compliance with cGMP (current Good Manufacturing Practice) norms stipulated by the USFDA. However, the risks are more pronounced in JPL's case given its small size and its smaller number of production facilities. The USFDA in December 2013 issued a warning to JPL for lapses found at the company's main contract manufacturing facility in Spokane, US.
The company managed to resolve the violations identified in the warning letter at the Spokane facility in a reasonable time frame of about 15 months and has demonstrated it is proactive in meeting quality compliance. This is reflected in USFDA inspections at all the company's six manufacturing facilities in the US during FY16 that did not find any lapses. JPL took steps to improve quality and management has become more proactive about maintaining standards as part of the resolution of the USFDA issues. We believe this should minimise the risk from future quality concerns.
Exposure to Commodity Prices: JLS is focused on products that are essentially commodities in nature, with realised prices and margins closely linked to crude-oil-based derivatives or substitutes and to demand and supply in the industry. The risk is more pronounced in chemical products at the lower end of the value chain, such as products in the life science ingredients business (ethanol and ethyl acetate) and advance intermediate segments (primarily pyridine). Low crude oil prices and industry overcapacity have led to weak operating trends in the life sciences business and are likely to limit any material improvement in the near to medium term. However, JLS's integrated business model provides it with some flexibility in shifting to products with better market fundamentals. For example, it stepped up production of specialty chemicals, which drove improvement in profitability in FY16.
Consolidated Financial Profile to Improve: JLS's FFO adjusted net leverage and FFO fixed charge coverage were 3.8x and 3.2x, respectively in FY16. We expect JLS's credit metrics to improve due to the expected growth in the pharmaceuticals business, a good degree of capex flexibility and moderate dividend payouts, which should enable it to generate positive free cash flows. Fitch expects the company to focus on expansion in segments with favourable demand, such as contract manufacturing, API and certain specialty ingredients. Currently, JPL's plant utilisation levels are at 60%-70% across most segments, which provide it with some operational and capex flexibility.
Fitch's key assumptions within the rating case for the issuer include:
- JLS revenue growth of around 4% in FY17 and 11%-13% after that, supported by new launches in the radiopharma and generic formulations businesses. Growth in the life sciences business to remain muted, reflecting weak commodity prices
- EBITDA margin to remain stable at close to 20% in FY17, before improving as the pharma business grows. Weak commodity prices and demand-supply imbalance in the speciality chemicals segment to limit improvement in life sciences margins
- Capex of nearly INR3.2bn in FY17. No material growth in capex after that - Dividend payout to remain at less than 15% of net income
Positive: Fitch does not anticipate any positive rating action in the near term given the challenges faced by JLS's life sciences business, which will limit the improvement in the credit profile of JLS. However, future developments that may, individually or collectively lead to positive rating action include:
- Sustained improvement in the operating profile of the life sciences business;
- Sustained free cash flow generation; and
- FFO adjusted gross leverage sustained at less than 2.5x (FY16: 4.1x).
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Volatility in free cash flow generation due to a weak operating environment in life sciences or adverse USFDA actions
- Deterioration in FFO adjusted gross leverage to more than 4.5x
JLS has adequate liquidity with cash balance of INR3.4bn and undrawn credit facilities of INR5.7bn at 31 March 2016, which are sufficient to cover the INR7.4bn of long-term debt maturing in the next 12 months. The debt maturity profile is reasonably balanced with less than INR7.5bn in annual debt maturities after FY17. The liquidity profile is further supported by Fitch's expectation of positive free cash flow in FY17 and proceeds from the proposed bond issuance, which will be used to repay debt within JPL.