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Pfizer: Dismal finish!

Jan 22, 2007

Performance summary
MNC pharma major, Pfizer India, announced poor results for the fourth quarter and year ended November 2006. For 4QCY06, while topline has grown by a mere 2% YoY, net profits have declined by 2% YoY. However, operating margins during the quarter have improved largely due to a considerable fall in purchase of finished goods (as percentage of sales). The subdued fourth quarter numbers have impacted the full year performance as well with topline registering a relatively slower growth of 11% YoY. However, for the full year, the bottomline has grown at a healthy double-digit pace due to the extraordinary income on the sale of its properties at Hyderabad and Ankleshwar.

Financial performance: A snapshot
(Rs m) 4QCY05 4QCY06 Change CY05 CY06 Change
Net sales 1,679 1,709 1.8% 5,985 6,624 10.7%
Expenditure 1,462 1,447 -1.0% 4,929 5,232 6.1%
Operating profit (EBIDTA) 217 261 20.6% 1,056 1,391 31.8%
Operating profit margin (%) 12.9% 15.3%   17.6% 21.0%  
Other income 119 120 0.7% 410 476 15.9%
Interest (net) - 1   2 1 -53.3%
Depreciation 40 31 -22.4% 139 131 -5.6%
Profit before tax 296 350 18.2% 1,326 1,736 30.9%
Exceptional items (expense) (34) (58) 70.8% (234) (115) -50.6%
Tax 88 121 37.8% 411 563 36.9%
Profit after tax 174 170 -2.1% 681 1,057 55.2%
Net profit margin (%) 10.3% 10.0%   11.4% 16.0%  
No. of shares (m) 29.8 29.8     29.8  
Diluted earnings per share (Rs)*         35.5  
P/E ratio (x)*         24.3  
(* on a trailing 12-month basis)

What is the company’s business?
Pfizer India is a 40% subsidiary of the world's largest pharmaceuticals company, Pfizer Inc. It has some strong brands in its portfolio like Corex, Becosules, Gelusil and Benadryl. Pfizer derives most of its revenues from the pharmaceuticals division (87%). The company also has presence in the animal health (9%) and clinical development operations (4%) segments. In the animal health segment, Pfizer plans to capitalise on its parent's global leader status and become a major player. Pfizer also carries out clinical trials on behalf of its parent.

What has driven performance in CY06?
Fourth quarter impacts topline: While Pfizer’s topline for the full year registered an 11% YoY growth, it was impacted by the poor performance in 4QCY06, which saw revenues grow by a mere 2% YoY. The company has attributed this subdued topline growth during the quarter to trade related issues in Maharashtra. Nevertheless, for the year, the topline growth can be attributed to the strong performance of its key brands such as ‘Corex’, ‘Becosules’, ‘Gelusil’ and ‘Listerine’. The company had launched three new products in 1QCY06 from its global parent’s product stable i.e. ‘Viagra’, ‘Caduet’ (cardiovascular) and ‘Lyrica’ (nerve pain), which have also contributed to the overall topline growth for the full year.

As we do not have the details of the segmental performance, we will not be able to comment on Pfizer’s other businesses, which include animal health and clinical services. It must be noted that in 9mCY06, revenues had clocked a 14% YoY growth, which at that time was in line with our estimates. After the staid topline growth in the fourth quarter, we will have to downgrade our topline numbers for the full year.

Margins expand: Tight control over operating costs coupled with a better product mix has contributed to the operating margin expansion (from 17.6% in CY05 to 21.0% in CY06). Decline in staff costs and other expenditure (both as percentage of revenues) also helped matters. However, the company’s purchase of finished goods remained stable during the year largely due to a considerable reduction of the same in the fourth quarter. Going forward, we expect operating margins to improve backed by improved field force productivity and a better product mix.

Cost break-up
(% of sales) 4QCY05 4QCY06 CY05 CY06
Material consumption 12.0% 13.1% 18.4% 18.0%
Purchase of finished goods 20.1% 9.8% 15.8% 15.7%
Staff cost 17.3% 15.9% 16.7% 15.5%
Other expenditure 37.6% 38.1% 31.4% 29.8%

Bottomline bloats: Pfizer’s bottomline grew by 55% YoY during CY06, backed by a strong performance at the operating level. This growth was further complemented by rise in other income and reduction in extraordinary expense. It must be noted that the company has been amortizing VRS expenses to the tune of around Rs 230 m every year for a period of 5 years. While the VRS expenses were amortized during both CY05 and CY06, the impact of the same was lesser during CY06, as Pfizer had received income on sale of its Hyderabad property (Rs 118 m) in 2QCY06. If one were to exclude the effect of extraordinary items, then the bottomline for CY06 has actually grown by 28% YoY.

Quarterly trend
  3QCY05 4QCY05 1QCY06 2QCY06 3QCY06 4QCY06
Net sales growth (YoY change) 15.0% 16.2% 9.8% 23.8% 9.7% 1.8%
Operating profit margin (%) 22.2% 12.9% 24.3% 22.0% 22.8% 15.3%
Net profit growth (YoY change) 62.2% 23.6% 84.0% 132.0% 28.6% -2.1%

What to expect?
At the current price of Rs 863, the stock is trading at a price to earnings multiple of 14.0 times our estimated CY08 earnings. We expect operating margins to improve going forward on the back of a healthy topline performance backed by existing and new products and continued efficiency at the operating level. The company has already launched three blockbuster drugs from its parent’s product portfolio in the Indian markets and is likely to introduce more such products going forward, which will provide a further impetus to the topline growth.

Pfizer is also undertaking a business restructuring exercise, wherein the company has created seven strategic business units (SBUs) on the basis of the core therapeutic categories it has been focusing on. This move is in line with its strategy to align its business model with that of its parent, thereby paving the way for possible new product launches in the future.

Investors should note that the parent company Pfizer Inc. had announced the global divesture of the Consumer Healthcare Business in June 2006 to Johnson & Johnson. Consequently, the global closure was fixed on December 20, 2006 except for few markets like India for divesture of the aforesaid Consumer Healthcare Business. The Board of Directors of Pfizer Ltd. in India is still evaluating the impact of the same on the Indian operations. Given the fact that the company has performed poorly during the quarter, we will have to accordingly downgrade our topline and operating margin numbers for the full year.

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