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Nicholas Piramal: No relief! - Views on News from Equitymaster
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Nicholas Piramal: No relief!
Jan 19, 2006

Performance summary
Nicholas Piramal announced subdued results for the third quarter and nine months ended December 2005. While the company’s topline growth during the quarter was largely driven by a strong exports performance, loss of Phensedyl and Valdecoxib sales impacted margins. A substantial reduction in other income and an extraordinary income received in 3QFY05 contributed to the steep 70% YoY fall in bottomline. If one were to exclude this extraordinary effect, then the bottomline declined by 10% YoY.

Standalone snapshot
(Rs m) 3QFY05 3QFY06** Change 9mFY05 9mFY06 Change
Net sales 3,279 3,569 8.9% 10,307 10,820 5.0%
Expenditure 2,719 3,127 15.0% 8,331 9,053 8.7%
Operating profit (EBDITA) 560 442 -20.9% 1,976 1,767 -10.6%
EBDITA margin (%) 17.1% 12.4%   19.2% 16.3%  
Other income 15 4 -72.3% 137 243 77.7%
Interest (net) 39 14 -63.9% 106 112 5.3%
Depreciation 119 146 22.4% 339 425 25.3%
Profit before tax 416 286 -31.1% 1,668 1,473 -11.7%
Extraordinary item 523 (1) -100.3% 500 (7) -101.4%
Tax 149 48 -68.2% 347 138 -60.2%
Profit after tax/(loss) 789 237 -69.9% 1,821 1,328 -27.1%
Net profit margin (%) 24.1% 6.7%   17.7% 12.3%  
No. of shares (m) 190.0 209.0   190.0 209.0  
Diluted earnings per share (Rs)*         5.8  
Price to earnings ratio (x)*         45.9  
(* trailing twelve months)            
** Includes Rhodia Inhalation Anesthetics business not present in 3QFY05

What is the company’s business?
Nicholas Piramal India Ltd. is one of the leading Indian pharma companies with strong focus on the domestic market. It is the fourth largest company in the domestic market with a share of 4.3% (FY05) and a large sales force covering 10 therapeutic segments. The company has gradually improved its product portfolio by increasing the share of lifestyle drugs and has also focused on R&D of late. The biggest contributors to company’s revenues are the respiratory and cardiovascular segments. The other major therapeutic segments in which the company operates are anti-infectives, nutritional, and gastro intestinal. Nicholas Piramal has also identified custom manufacturing as its area of growth going forward. With this aim in mind, the company has signed five contracts to date and also recently acquired the contract-manufacturing organisation (CMO), Avecia Pharmaceuticals, UK to establish a footprint in the global custom manufacturing space.

What has driven performance in 3QFY06?
Exports drive revenue growth: Revenues for the quarter recorded a 9% YoY growth, largely due to a strong 66% YoY growth in exports. The exports contribution to the total revenues during the quarter stood at 18.4% (12% in 3QFY05). In addition to this, the company’s first contract manufacturing agreement with Advanced Medical Optics increased to Rs 80.9 m during the quarter. It must be noted that this contract started generating revenues in 2QFY06.

The domestic formulations business grew above the market rate, the exception being respiratory, NSAIDs and anti-infective segments. It must be noted that in the respiratory segment, the company’s top brand ‘Phensedyl’ was faced with a controversy in 2QFY06 when the Narcotics Bureau classified the product as a narcotic. While Nicholas Piramal was successful in counteracting the charge, the brand recorded a decline in sales to the tune of Rs 250 m in 2QFY06 and Rs 100 m in 3QFY06.

Contraction in margins: Margins during the quarter shrunk to 12.4% in 3QFY06 as against 16.6% in 3QFY05 due to an increase in expenses, chiefly promotion and selling costs. The high promotion expenditure can be attributed to the various brand-building measures taken by the company including that for the beleaguered ‘Phensedyl’. Lower sales of ‘Phensedyl’ and withdrawal of two Valdecoxib brands ‘Vah/Valto’, in which Nicholas is a leader and a marked-to-market forex loss of Rs 20.9 m also affected margins.

Standalone cost break-up
(% of sales) 3QFY05 3QFY06 9mFY05 9mFY06
Raw material 44.6% 41.0% 42.8% 43.4%
Staff cost 10.3% 11.1% 10.7% 10.7%
Other expenditure 23.2% 27.3% 23.8% 25.4%
R&D expenses 4.9% 4.6% 3.5% 4.2%

The extraordinary effect: Bottomline during the quarter fell by 70% YoY. However it must be noted that in 3QFY05, the company had received a one-time income from Roche Diagnostics after Nicholas had snapped ties with the latter, which was not present in the current quarter. Therefore, if one were to exclude this extraordinary item, then the bottomline declined by 10% YoY. The decline in bottomline was aided by a sharp fall in other income, which fell 72% YoY.

Over the last few quarters: Nicholas’ revenue growth has been rather inconsistent, which could be attributed to the snapping of ties with Roche Diagnostics (an international pharma company), VAT related concerns in 4QFY05 and the ‘Phensedyl’ controversy in 2QFY06. However, with the exception of 4QFY05 and the current quarter, the company has managed to consistently maintain operating margins above 16%.

Quarterly trend
(%) 2QFY05 3QFY05 4QFY05* 1QFY06 2QFY06 3QFY06
Net sales growth 2.0% 9.0% -31.0% 8.8% -2.3% 8.9%
Operating profit margin 21.9% 16.6% -9.2% 18.9% 17.6% 12.4%
Net profit growth 7.0% 99.4% - 12.2% 0.9% -69.9%
*Net loss in 4QFY05

What to expect?
At the current price of Rs 266, the stock is trading at a price to earnings multiple of 22.2 times our estimated FY08 earnings, which is at the higher end of our valuation spectrum. Going forward, we believe that the contract manufacturing business will gain significant momentum. The company already signed 2 contracts in FY05 and in 9mFY06, it has signed 3 such contracts with AstraZeneca, another company which is a global hospital products company and Pfizer International LLC. However, we believe that these contracts will start generating revenues FY08 onwards.

Also, the acquisition of the European contract-manufacturing organisation (CMO), Avecia Pharmaceuticals, will further enable it to establish a footprint in the global CMO space. However, Avecia is currently a loss making company and is likely to breakeven only by FY08. Therefore while we are positive about the future growth prospects of the company, we believe that the current stock price more than adequately reflects this growth and to that extent we advise investors to exercise caution.

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