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Cipla: Subdued quarter - Views on News from Equitymaster
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Cipla: Subdued quarter
Jan 23, 2007

Introduction to results
Cipla has announced subdued results for the third quarter and nine-months ended December 2006. Revenue growth of 12% YoY has been much slower than what was witnessed in the previous two quarters of this fiscal. This was largely due to a substantial decline in API exports. Margins have, however, expanded on the back of a considerable reduction (as percentage of sales) in other expenditure. Bottomline growth has been muted at 5% YoY, mainly due to a substantial reduction in other income.

Financial performance: A snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 7,833 8,805 12.4% 21,049 26,337 25.1%
Expenditure 6,243 6,613 5.9% 16,183 19,579 21.0%
Operating profit (EBIDTA) 1,589 2,193 38.0% 4,866 6,757 38.9%
Operating profit margin (%) 20.3% 24.9%   23.1% 25.7%  
Other income 745 261 -64.9% 838 671 -20.0%
Interest 51 13 -74.0% 81 57 -30.3%
Depreciation 230 275 19.6% 580 780 34.5%
Profit before tax 2,053 2,166 5.5% 5,043 6,591 30.7%
Tax 300 322 7.3% 950 1,241 30.6%
Profit after tax/ (loss) 1,753 1,844 5.2% 4,093 5,351 30.7%
Net profit margin (%) 22.4% 20.9%   19.4% 20.3%  
No. of shares (m) 299.9 777.2   299.9 777.2  
Diluted earnings per share (Rs)*         9.3  
P/E ratio (x)*         27.3  
(* on a trailing 12-months basis)

What is the company’s business?
Cipla is the second largest pharma company in the domestic retail market (ORG survey) and has presence in formulations and bulk drugs manufacturing. All the bulk drug manufacturing facilities of the company have been approved by the US FDA and the formulation facilities have been approved by the Medicine Control Agency (UK), the Medicine Control Council (South Africa), the Therapeutic Goods Administration (Australia) and other international agencies. On the exports front, the company has strategic alliance with major generic manufactures such as Watson, Mylan, Barr and Ivax for supply of bulk drugs. It has a very wide product range in the domestic market, which includes antibiotics, anti-bacterial, anti-asthmatics, anti-inflammatory, antiretroviral, anti-cancer and cardiovascular. The company also concentrates on developing specialty bulk drugs for export markets.

What has driven performance in 3QFY07?
API exports play spoilsport: Cipla clocked a 12% YoY topline growth during the quarter, which was much slower than the robust revenue growth witnessed in the previous two quarters. While the domestic business grew by 10% YoY, exports growth (up 8% YoY) was subdued mainly due to the 35% YoY decline in API export sales. This decline was attributed to the high base effect last quarter when API exports to the regulated markets was much higher. Formulation exports, however, grew by a robust 35% YoY and were thereby instrumental in propping up the overall exports growth.

Business snapshot
  3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Domestic 3,961 4,353 9.9% 11,531 13,526 17.3%
Exports
- Formulations 2,361 3,197 35.4% 6,995 9,184 31.3%
- APIs 1,503 982 -34.7% 2,922 3,330 14.0%
Total exports 3,864 4,179 8.2% 9,916 12,514 26.2%
Total sales 7,824 8,532 9.0% 21,447 26,040 21.4%
Other operating income
- Technology knowhow/fees 255 258 1.1% 353 468 32.4%
- Others 40 256 534.5% 300 559 86.2%
Total 295 513 73.9% 654 1,027 57.1%
Total income from operations 8,119 9,045 11.4% 22,101 27,067 22.5%

Margin improvement visible: Operating margins have improved by 460 basis points during the quarter on the back of a considerable reduction in other expenditure. The company has attributed this decline to lower factory overheads and accrual of foreign exchange gains. While the company has managed to keep its raw material costs under control, staff costs (as percentage of sales) have risen due to an increase in managerial remuneration as well as overall manpower. Going forward, though we expect API exports to grow faster than formulations, we expect Cipla to maintain operating margins at around 23% levels mainly due to a higher contribution of formulations (which enjoy higher margins than APIs) to total sales.

Cost break-up
(% of sales) 3QFY06 3QFY07 9mFY06 9mFY07
Raw material cost 49.4% 49.2% 47.2% 46.7%
Staff cost 4.5% 5.2% 5.0% 5.4%
Other expenditure 25.8% 20.7% 24.7% 22.3%

The bottomline picture: Bottomline has grown by a mere 5% and has under performed the operating profit growth during the quarter largely due to a substantial reduction in other income. Even a sharp fall in interest costs (due to the repayment of short term borrowings) could do nothing to boost the bottomline.

Over the quarters: Barring this quarter, Cipla’s growth at both the topline and bottomline levels has been commendable over the past few quarters. This is due to its low-risk strategy of supplying bulk drugs to global generic companies. As its partners begin to receive ANDA approvals in the generic markets, we expect Cipla’s bulk drugs exports to pick up pace going forward. However, it must be noted that during quarters wherein API sales have outpaced formulation sales, operating margins have been comparatively lower.

Quarterly trend
  2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07
Net sales growth 15.5% 30.9% 62.7% 30.3% 33.3% 12.4%
Operating profit margin 26.4% 20.4% 20.7% 26.5% 25.4% 24.9%
Net profit growth 27.9% 39.5% 80.7% 53.0% 45.8% 5.2%

What to expect?
At the current price of Rs 254, the stock is trading at a multiple of 18.1 times our estimated FY09 earnings, which is at the higher end of the valuation spectrum. We believe that, going forward, Cipla’s focus on contract manufacturing shall gather momentum in the future keeping in mind the global generics potential. In the domestic market, the company is likely to maintain its strength with its strong field presence and strong brands. Having said that, despite the positives, the stock seems to be fairly priced with limited upside and to that extent, we advise investors to exercise caution.

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