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Novartis: Slipping once again

Jan 28, 2005

Performance summary
MNC pharma company, Novartis India, has declared its 3QFY05 and 9mFY05 results. The topline of the company has registered a decline of 7%, while the bottomline has fallen more significantly by 55%. However, the performance of the company at the operational level was not that bad. The operating profit margin was down 90 basis points only, the profit before tax was down by 6%.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 1,453 1,352 -7.0% 4,026 3,924 -2.5%
Expenditure 1,127 1,059 -6.0% 3,369 3,126 -7.2%
Operating profit (EBDITA) 327 293 -10.4% 657 798 21.4%
Operating profit margin (%) 22.5% 21.6%   16.3% 20.3%  
Other income 72 57 -20.8% 371 220 -40.8%
Interest 2 2 -27.3% 6 5 -23.0%
Depreciation 39 13 -66.0% 116 39 -66.0%
Profit before tax 357 334 -6.3% 906 973 7.4%
Tax (131) 116   (23) 327  
Profit after tax/(loss) 488 218 -55.3% 929 647 -30.4%
Net profit margin (%) 33.6% 16.1%   23.1% 16.5%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)* 61.1 27.3   38.8 27.0  
P/E ratio (x)         21.2  
(* annualised)            

What is the company's business?
Novartis is a leading player in certain therapeutic segments, with strong brands like Voveron, Tegrital and Calcium Sandoz. The company has a strong presence in anti-TB, respiratory and anti inflammation segments. Also, it has a very strong parent back up which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has a no manufacturing operations in India and all the products that Novartis sells are either out-sourced from the local producer or imported from the parent company. Thus, this company should be seen as a trading company rather than a drug manufacturing company. This puts a question mark on the company's seriousness about the Indian market.

What has driven performance in 3QFY05?
Sales:  The major factor behind the decline in sales (down 7% YoY) is poor performance in 3 out of 4 segments the company operates in. The pharmaceutical segment witnessed a decline of 8.9%, while generics segment de-grew by 13%. The animal health care segment also showed a decline of 11% in the quarter. The sales in the animal health care segment fell in the recent past, as the company has discontinued one of the top selling product ‘organophosphorus'. On the positive side, the company's focus on the OTC segment helped it to grow by 18%, and this is likely to gain further momentum going forward. The growth in the pharmaceutical segment seems to be marred by the reduction in prices of TB drugs. The company is planning to exit the TB drug business by selling out its Ramificin plant.

On positive side, the company is now targeting tier II / tier III cities and towns in the country to diversify its revenue base geographically. This initiative, though time consuming, will improve the company's revenue growth going forward.

Segmental revenue share Sales   PBIT Margin
3QFY04 3QFY05 Change 3QFY04 3QFY05
Pharmaceutical 888 809 -8.9% 30.6% 25.0%
(as % of total sales) 61.1% 59.9%      
Generics 294 255 -13.1% 8.4% 19.8%
(as % of total sales) 20.2% 18.9%      
OTC 155 184 18.6% 23.6% 21.4%
(as % of total sales) 10.7% 13.6%      
Animal Health 116 103 -11.3% 25.1% 29.0%
(as % of total sales) 8.0% 7.6%      
Total 1,453 1,352 -7.0% 24.6% 24.7%

Operating margins:  Despite a decline at the topline, the affect was not very much visible at operating level. The operating profit margin of the company was marginally down at 21.6%. This could be attributed to better sales mix. The raw material costs have come down significantly in the quarter. So is the case with the purchase of trading goods.

Cost break-up
  3QFY04 3QFY05 Change
Raw Material 145 107 -26.6%
(as % of sales) 12.9% 10.1%  
Staff Cost 109 103 -5.5%
(as % of sales) 9.7% 9.8%  
Purchase of Traded Goods 555 480 -13.6%
(as % of sales) 49.3% 45.3%  
Other Expenditure 317 370 16.6%
(as % of sales) 28.1% 34.9%  
Total 1,127 1,059 -6.0%

Net profit:  The dismal performance of the company continues at the net level too. The net profit of the company has declined by 55% in the quarter. Lower other income, compounded by higher tax incidence has resulted in huge decline in PAT. The refund by the income tax authorities in the same quarter last year resulted in an inflow on tax front. Apart from this, the effective tax rate in 3QFY05 also includes tax on prior period profits, including significant income from sale of property (attracting lower tax rate) and the deferred tax credit arising from impairment of company's assets.

What to expect?
At Rs 572, the stock is trading at 21.2x its annualised 9mFY05 earnings. Novartis is a leading multinational pharma company with some strong brands. Historically the valuations of this company have been at a discount to its peers for reasons such as lower penetration in the markets and absence of manufacturing activity. However, the initiative taken by the company to expand geographically augurs well for future growth. Also, with the new patent regime the company will be in position to launch patented products in the Indian markets giving it further growth opportunities. Novartis is pretty clear about launching new products and is revamping its operations for the same. However, till that time Novartis will be seen as a trading company and will get a lower valuation compared to top MNC pharma companies.

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