AOB Misses on EPS and Revs - Analyst Blog

American Oriental Bioengineering’s (AOB) second quarter fiscal 2010 earnings per share (EPS) came in at 7 cents per share, lower than the Zacks Consensus Estimate by 3 cents and the year-ago earnings by 9 cents. Although revenues increased from the year-ago period, earnings declined due to higher operating expenses.
 
Revenues in the reported quarter climbed 8.5% year over year to $77.3 million but fell short of the Zacks Consensus Revenue Estimate of $80 million. The year-over-year increase in revenue was driven by the strong sales of the company’s prescription products.
 
American Oriental earns revenue from two operating segments–Manufacturing and Distribution. While the Manufacturing business accounted for more than 95.4% of the company’s total revenue, the Distribution business – Nuo Hua generated $3.6 million in sales, accounting for the remaining 4.6%.
 
American Oriental records Manufacturing revenues from two sources – Pharmaceutical and Nutraceutical products. Sales from the two product lines increased 9.1% to $63.8 million and 4.3% to $9.1 million, respectively, compared with the second quarter of 2009.
 
Revenues from prescription pharmaceutical products increased 20.8% to $30.4 million during the quarter, primarily driven by increased sales of Jinji capsule, SHL powder, YYQH capsule and the expansion of CCXA generic pharmaceutical products in the rural market. We believe prescription drug sales will continue their growth trajectory as China is aiming at reforming its health care sector to incorporate the unaddressed rural markets. Revenues from OTC pharmaceutical products remained flat at $33.4 million in the quarter.
 
While American Oriental recorded an increase in revenues, its gross profit margin deteriorated during the quarter. Gross profit declined 4.3% to $39.8 million in the reported quarter. Gross margin for the second quarter of 2010 stood at 51.5% compared with 58.4% in the prior-year period.  The decrease was attributable to a higher proportion of generic product sales in the rural market. Furthermore, higher raw material prices also brought down the margin.
 
Operating expenses in the reported quarter climbed 29.7% year over year to $30.6 million. Research and development (R&D) expenses jumped 312% to $3.3 million during the quarter. The sharp increase was attributable to the company’s heavy investments in R&D to upgrade its existing product portfolio.
 
Our Take & Recommendation
 
We are pleased by the increase in American Oriental’s revenues in the most recent quarter, driven by strong sales of the company’s products. We believe prescription drug sales will continue increasing since China is aiming to reform its health care sector by incorporating unaddressed rural markets. However, the dependence of the company on few products to generate the bulk of its revenues is quite a risk. Furthermore, the excessive competition confronting the company’s products is also a concern.
 
Consequently, we believe that the risk/reward profile at American Oriental is balanced and this forms the basis of the short-term Zacks#3 Rank (‘Hold’) and the long-term Neutral stance on the stock.
 
The lack of estimate revisions by the analysts following American Oriental indicates the absence of a clear directional pressure on the stock. This supports our short-term and long-term stance on the stock.