Product Concentration Risk And Lack Of New Products Make Amphastar Overvalued

| About: Amphastar (AMPH)
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Summary

Amphastar inexplicably trades at a premium to its peers.

The company received a CRL on its top proprietary candidate which will hurt 2017 earnings.

Amphastar faces the same problems as Akorn and Impax but is valued twice as highly.

Shares are worth $12-14.

Amphastar (NASDAQ:AMPH), founded in 1996, is an international manufacturer and seller of generic and uniquely formulated drug products. Shares of the company were recently punished by the company receiving a complete response letter ("CRL") that it received on its new drug application ("NDA") for Primatene Mist - an inhalable epinephrine that was previously the only over-the-counter ("OTC") asthma inhaler available. The market had expectations for the product, sending shares down roughly 9%. I believe the product delay, coupled with issues with one of its top products, enoxaparin, has created a tremendous amount of earnings uncertainty for 2017. I believe shares are currently trading at a price that suggests a takeover is imminent. While a takeover is a risk, I believe Amphastar will struggle in 2017, and I believe shares have a downside to about $12-14.

Company background

Amphastar has remained mostly under the radar since coming public in 2014, and I believe this is largely due to its relatively small size and low profitability. The company was founded in 1996, and it has 60 buildings with a global manufacturing footprint that encompasses Rancho Cucamonga and South El Monte, California; Canton, Massachusetts; Éragny-sur-Epte, France; and Nanjing, China. Manufacturing is particularly important in generic drugs as compliance with FDA and GMP regulations are arduous, complex, and generally difficult.

Companies, particularly in the more complex injectable and inhalable space, receive Form 483 warning letters that tell the manufacturer that its practices need to improve. While it sounds frightening, and it is occasionally, a quality issue can be relatively benign (process documentation issues) or critical (particulate matter) that causes a plant to be shut down. Amphastar is not immune from receiving 483s, as it received observations in 2015 and 2016. I have not used the FOIA system to request the content of these warning letters, but we can be assured that they are of the relatively minor variety, as the plant did not need to be shut down.

Even more critical than regulatory compliance, Amphastar possesses strong technical capabilities. Injectable and inhalation products are already difficult to manufacture, and Amphastar also possesses the ability to make hormones like insulin and biosimilars that fill the pipeline. Because of this differentiated capability, Amphastar is able to receive relatively strong pricing and enjoy lower levels of competition. Such has been the case with enoxaparin sodium and epinephrine - two difficult-to-manufacture products that have provided a reliable source of earnings.

Earnings concentration a concern

Finished pharmaceutical products net revenues:

Q3'16

Q3'15

y/y change

YTD 16

YTD 15

y/y change

Enoxaparin

$15,363

$21,264

-27.8%

$51,049

$64,647

-21.0%

Naloxone

$12,407

$10,519

17.9%

$38,222

$27,944

36.8%

Lidocaine

$8,279

$6,176

34.1%

$26,378

$20,662

27.7%

Phytonadione

$8,667

$5,935

46.0%

$23,555

$10,301

128.7%

Epinephrine

$5,303

$5,032

5.4%

$14,921

$9,958

49.8%

Other finished pharmaceutical products

$9,039

$8,976

0.7%

$27,243

$25,337

7.5%

Total Finished Product Revenue

$59,058

$57,902

2.0%

$181,368

$158,849

14.2%

Source: AMPH 2016 3Q 10-Q Report

Overall, Amphastar has a concentrated revenue mix with its top 5 products accounting for ~85% of product revenue. While it is not out of the ordinary for a generics company to have high levels of product sales concentration, five is a bit too concentrated for my liking.

Furthermore, the company is going to have some serious enoxaparin issues in 2017. Pricing in the enoxaparin market has become more competitive, and former partner Actavis (now owned by Teva (NYSE:TEVA)) discontinued its distribution relationship with Amphastar after the acquisition was finalized. Amphastar will now sell the product directly to customers, but it will not experience a profitability tailwind, as I believe existing competitors will battle to maintain market share. Although I believe Amphastar may have a slight cost benefit due to its heparin relationship in China, I anticipate the competitive atmosphere will keep depressed margins on the product. Additionally, I believe, as a much smaller competitor, Amphastar will have a difficult time gaining market share.

Regardless of the enoxaparin hiccup, gross profit seems to be increasing, jumping to 44% YTD in 2016 from 25.3% YTD in 2015. Amphastar has added just an incremental $17 million in sales but an incremental $40 million in gross profit. Although some of the improved profitability comes from overhead absorption, I suspect most of the improvement is coming from pricing and one-off events. Naloxone demand increased sharply after a Federal regulation was passed mandating that all pharmacies keep the product stocked for heroin overdose recovery. Inventory stocking could prove to be transient. Lidocaine, epinephrine, and phytonadione look like classic price increases, in my view. Epinephrine is a fairly uncompetitive environment, as is phytonadione, which has just two competitors. These specific market dynamics scare me as revenue could decline massively if a new competitor enters either market. It is a headwind that constantly clouds Akorn (NASDAQ:AKRX), but the situation is even worse for Amphastar.

As mentioned earlier, Amphastar received a complete response letter ("CRL") on its Primatene Mist product. As the only OTC asthma inhaler, I believe the product was poised to generate the majority of sales growth in 2017, and given the product's complexity, it may be difficult to bring it back to the market. Management noted that the concerns in the CRL would be addressed by the middle of 2017, ensuring investors that the problem is fairly material. Something minor could take 6-8 weeks to respond. This is the second CRL on the product, and if the company receives one more, I believe it could abandon development.

Source: AMPH 10-K 2015

In addition to Primatene Mist, Amphastar has 12 generic ANDAs and three biosimilars in its pipeline. Therapeutic area matters little to me as I believe customers purchase nearly exclusively on price and supply continuity. Amphastar possesses some differentiated manufacturing capabilities, so I do believe some of its pipeline products may experience smaller levels of competition. That being said, increased technical complexity makes the approval scenario less of a slam dunk. Amphastar could receive enough CRLs to prompt the company to abandon development.

On the more positive side, the company acquired 14 ANDAs from Hikma (OTCPK:HKMPF) that it will be able to commercialize in due time. Unfortunately, if the situation plays out like recent divestitures, the competitive environment could be more robust than anticipated, leaving Amphastar shareholders without much value.

Source: AMPH Piper Jaffray Deck 2016

On the proprietary side, Amphastar owns six product candidates. Primatene Mist already received a CRL, Albuterol DPI is in Phase IIB, so I am not going to value that at this time, and Naloxone Intranasal has a PDUFA data upcoming in February. OTC Naloxone is an interesting idea in light of recent regulations that require all pharmacies to have this heroin recovery product in stock. The injectable Naloxone market is growing nicely in light of this new regulation, and I could see this ready-to-use ("RTU") product gaining market acceptance. It will take 3-5 years to ramp, but it should slot in nicely as a $40-50 million product.

What is Amphastar Worth?

Generic companies can be fairly difficult to value due to the variance in earnings from product introduction and pricing swings. As a result, I have taken a range-based approach to valuing Amphastar based on a few outcomes.

In the event of a complete failure for Primatene Mist, I believe shares are worth about $12. This consists of a 9.5% WACC and 2% PGR, and it assumes Amphastar reaches $65M in EBITDA in 2020. In the event of a Primatene Mist approval as well as a slightly higher PTRS for Naloxone Intranasal, I think shares are worth $14, with the company reaching $65M in EBITDA in 2018.

In any event, relative to current multiples for peers like Akorn and Impax (IPXL), which trade at EV/EBITDA of 7.5x, shares of Amphastar already look largely overvalued, particularly as the company encounters the same product concentration risk as Akorn (except more severe) and the same M&A risk as Impax, though the products Amphastar acquired from Hikma are probably less risky than the products Impax acquired from Teva.

In any event, I think it is clear today that the market is far too optimistic about Amphastar. The primary upside risk to a short thesis is an acquisition - though I do not believe there is currently a logical fit due to Amphastar's poor gross margin profile. Regardless, I may establish a short position in the coming week, with my eyes on the March 17, 2017, $17.50 puts. The options are fairly illiquid, so one may be able to establish a well-priced position, though sizing will remain small.

Disclosure: I am/we are long AKRX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.