WuXi PharmaTech Model Changes Following First-Quarter Call

We are refining our model for WuXi following the release of first-quarter and revised 2014 guidance on Wednesday afternoon, May 14. We are reducing our 2014 adjusted EPS target by 15 cents to $1.83 (flat with 2013 and at the midpoint of the revised guidance range) to account for losses related to foreign exchange volatility and higher SG&A spending. In 2015, we are reducing our estimate by 12 cents to $2.15 (up 18%).

In addition, ASCO abstracts were released Wednesday evening, and based on the various abstracts that were published, it appears that Pharmacyclics’ (PCYC $100.00; Outperform) flagship drug, Imbruvica (for which WuXi produces active ingredients) may see some competition from AbbVie’s (ABBV $52.69) ABT-199. We believe the combination of the larger negative foreign exchange impact as well as selling pressure on Pharmacyclics drove a 9% correction in the stock despite another strong fundamental performance. We believe that as the RMB stabilizes and eventually resumes its strengthening against the U.S. dollar, the impact of the company’s hedges will be dramatically reduced. We therefore view Thursday’s weakness as a buying opportunity given the strong underlying fundamentals. We reiterate our Outperform rating on WuXi.

During the quarter, mark-to-market losses of $0.19 per share relating to the company’s hedges were a significant headwind to earnings growth. For the balance of the year, given the stabilization of the RMB at roughly 6.2 per U.S. dollar, earnings are expected to be affected by only another penny— so there are no more material hedging losses expected for the remainder of the year. On the operating line, the weaker RMB in the first quarter benefited the company’s EPS by 3 cents and is expect to be a10- to 15-cent tailwind for the full year, partly offsetting the hedging losses already recognized.

We do not expect any more significant additional unrealized losses from hedges for the remainder of this year or next if current rates hold, but expect some realized losses to take place in 2015 as the current forward contracts settle. To summarize these puts and takes, in the first quarter currency hurt EPS on a net basis by 16 cents. For the full year, it is expected to hurt EPS by 5-10 cents, which suggests the company will actually see a net benefit from currency over the remainder of the year of 6 to 11 cents if current rates are maintained.