Risk, Reward Balanced at AOB - Analyst Blog

We are maintaining our ‘Neutral' recommendation on American Oriental Bioengineering Inc. (AOB) with a target price of $2.25.

American Oriental Bioengineering, based in Beijing, China, together with its wholly owned subsidiaries, is a pharmaceutical company which develops, manufactures and commercializes both plant-based pharmaceutical (PBP) and plant-based nutraceutical (PBN) products.

American Oriental Bioengineering recently reported third quarter 2010 earnings per share of $0.07, which fell short of  year-ago earnings by $0.06 despite a 16.1% increase in revenues. Revenues were driven by the strong sales of the company's prescription products. The earnings decline was attributable to higher operating expenses.

We are encouraged by the strong showing of American Oriental's prescription products. We believe prescription drug sales will continue their growth as China aims at reforming its health care sector to incorporate unaddressed rural markets.

Moreover, the growth-by-acquisition strategy of the company is encouraging, and has helped expand its product portfolio and drive growth. For example, the acquisition of Nuo Hua Investment Company Ltd. in 2008 caused the distribution of pharmaceutical products to become part of the company's operations. We believe that such profitable acquisitions in future will aid the company's growth. Furthermore, the rapidly growing Chinese pharma market provides a lucrative opportunity to American Oriental to boost its top-line.

However, the dependence of the company on a few products to generate the bulk of its revenues is a risk. Furthermore, the excessive competition confronting the company's products is also a concern. Additionally, the steadily declining operating margin at American Oriental due to rising operating expenses is another concern. If this declining trend continues in the forthcoming quarters, the company's bottom-line will be severely affected.

These headwinds, reflecting near-term pressure on the stock, justify the Zacks #4 Rank (short-term ‘Sell' recommendation) carried by American Oriental. However, the stable outlook in the long term driven by the rapidly growing Chinese pharma market leads us to believe that the risk/reward profile at American Oriental is balanced in the long run. Consequently, we have a ‘Neutral' stance on the stock.