Caraco Pharma Awaits FDA Inspection in May Print
Wednesday, 04 February 2009 04:11

I spoke with the investor relations representative for Caraco Pharma (CPD) earlier this week and received some clarity on the expected timeline for resolving the major overhang on the stock price related to the FDA warning letter over Form 483 concerns by the agency stemming from quality control issues raised during an inspection of manufacturing facilities last year.


Caraco has responded in full to the warning letter and the FDA will evaluate the corrective actions taken by the Company at its next scheduled inspection, which is expected to occur some time in May. Caraco believes it is compliant with the FDA's cGMP regulations related to manufacturing and quality control and the issue remains the top focus at the Company, reflected by investments in personnel and facility upgrades.


The Company expects the FDA inspection in May to be the final step in resolving the warning letter issues as the agency will evaluate Caraco's upgrades in manufacturing and quality control at the Detroit facility to determine if these actions satisfy the agency's Form 483 concerns.


Once the FDA completes its inspection and is satisfied with the corrective actions, Caraco will be eligible to receive new generic drug product approvals from the Detroit facility (please note that the sale of currently marketed products was not affected by the warning letter) – removing all uncertainties currently weighing on the stock price, which has lost nearly three-quarters of market value in the past year.

CPD reported results for its fiscal 3Q09 in late January, including $55.7M in revenue and net income of $5.1M, which was down from the year-ago period revenue of $81.9M and net income of $10.8M. The year-ago period benefited substantially from the 180-day exclusivity period associated with the generic drug launch of oxcarbazepine (Trileptal) in conjunction with Sun Pharma (SUNPHARMA.NS).

Caraco noted that full-year revenue for fiscal 2009 is expected to be about the same as the previous year, reflecting uncertainty over the at-risk launch of generic Protonix (pantoprazole) and lower sales of oxcarbazepine since the exclusivity period has ended. Gross profit margin through the first nine months of FY09 declined to 21% from 36% in the year-ago period due to a higher mix of sales from distributed products, which have a much lower margin compared to manufactured products, with the latter posting 48% profit margin for the fiscal year to-date.

For the first nine months of FY09, Caraco filed six abbreviated new drug applications (ANDAs) related to five new generic drug products with a total of 25 pending ANDAs related to 21 new generic drug products. Caraco ended the calendar year with $34M in cash and $104M in working capital and expects cash flow from operations will be sufficient to fund its business plans, including the expansion of manufacturing facilities in Detroit which is nearly complete. Caraco is currently debt free and would only consider taking on debt for strategic acquisitions.

Sun Pharma is India's largest generic drug company by market cap which is a major strategic partner and holds a majority stake (around 75%) in Caraco through stock purchases and product/technology transfer agreements. Sun Pharma recently acquired Chattanooga, TN-based Chattem Chemical to strengthen its presence in the highly regulated market for controlled drug products, as Chattem is a registered with the DEA as an importer and manufacturer of active pharmaceutical ingredients (APIs) for a variety of Schedule 1-5 controlled substances.

Caraco Pharma offers U.S. investors a way to play Sun Pharma's growth through their distribution agreement and the Company believes it has addressed the issues raised in the FDA warning letter completely, which provides a potential upside catalyst upon resolution. Also, Caraco is committed to product development agreements with other companies and internal R&D efforts focused on formulations aimed at expanding its product offerings.

The following is a summary of the valuation parameters for Caraco:

1.) CPD Market Cap = $142M, stock price around 4 bucks

2.) Trailing 12-month Revenue = $478M, Net Income = $34.4M

3.) Price/Sales Ratio (PSR) = 0.31X, Trailing Price/Earnings Ratio = 4.8X

4.) Enterprise Value (EV)/EBITDA Ratio = 3.5X, EV/Sales Ratio = 0.39X

5.) Price/Book Ratio = 1.16X

Favorable growth trends for the generic drug industry include nearly $70B in brand name drug sales with patent expirations through 2012, a push to increase generic substitution rates from 65% of all prescriptions dispensed to over 70%, continued industry consolidation of small and mid-caps by industry leaders such as Teva Pharma (TEVA) and Mylan Labs (MYL), and the potential for legislation this year regarding generic versions of high-cost biological agents.

Major U.S. listed generic drug makers such as TEVA, MYL, and Watson Pharma (WPI) have posted strong operating results and stock price gains over the past three months. MYL has more than doubled from multi-year lows late last year when it was trading at similar value parameters to where Caraco currently trades.

The upcoming FDA inspection, strategic relationship with Sun Pharma, 25 pending ANDAs, and value parameters for Caraco position the stock well for long-term growth and gains if you believe the Company has adequately addressed the warning letter issues through personnel and facility upgrades to satisfy the concerns of the FDA.


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