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Novartis: Poor show continues… - Views on News from Equitymaster
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Novartis: Poor show continues…
Jan 29, 2007

Performance summary
Novartis has announced mixed results for the third quarter and nine months ended December 2006. The topline performance for the quarter was largely driven by its animal health and pharmaceutical businesses. The generics business continued with its poor run this quarter as well. Operating margins improved mainly due to a considerable reduction in raw material costs. Despite the increase in other income, bottomline has declined by 9% YoY during 3QFY07, owing to a higher tax outgo.

Financial performance: A snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 1,383 1,487 7.6% 4,212 4,184 -0.7%
Expenditure 1,168 1,241 6.3% 3,471 3,447 -0.7%
Operating profit (EBDITA) 215 246 14.7% 741 737 -0.5%
EBDITA margin (%) 15.5% 16.6%   17.6% 17.6%  
Other income 72 90 25.6% 205 293 42.6%
Interest (net) 2 2 -25.0% 24 4 -82.3%
Depreciation 8 7 -13.3% (1) 20  
Profit before tax 277 329 18.5% 923 1,006 9.0%
Tax 47 118 153.0% 331 359 8.6%
Extraordinary item - -   287 -  
Profit after tax/(loss) 231 211 -8.6% 879 647 -26.4%
Net profit margin (%) 16.7% 14.2%   20.9% 15.5%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)*         26.5  
Price to earnings ratio (x)*         13.9  
(* on a trailing 12-months basis)            

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 the anti-TB, respiratory and anti-inflammation segments. Also, it has a very strong parent backup, which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has no manufacturing operations in India and all the products that Novartis sells are either outsourced from a local producer or imported from the parent company. Thus, this company should be seen as a trading company rather than a drug manufacturing company.

What has driven performance in 3QFY07?
Staid revenue growth: Revenues during the quarter grew by 8% YoY, which was largely driven by its pharmaceuticals (up 8% YoY) and animal healthcare segments (up 15% YoY). While in 2QFY07, the OTC segment reported a robust 36% YoY growth, the growth this quarter was relatively subdued. For the nine-month period, the revenue growth of the pharmaceuticals business was flat due to one of its key products ‘Tegrital’ being subject to significant price control. Revenues from the generics segment declined by 1% YoY and 25% YoY during 3QFY07 and 9mFY07 respectively, as the company opted not to participate in the low margin tender business in the anti-TB segment. The OTC segment, however, was the strongest performer of the lot clocking a decent 11% YoY growth during 9mFY07, which was attributed mainly to successful calcium variant launches and increased market reach.

Segmental performance
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Pharmaceuticals 900 975 8.3% 2,874 2,875 0.0%
PBIT margin (%) 16.8% 18.6%   23.8% 20.6%  
Generics 121 120 -1.2% 452 341 -24.6%
PBIT margin (%) 26.0% 33.2%   32.1% 32.9%  
OTC 254 270 6.2% 602 670 11.4%
PBIT margin (%) 22.6% 23.4%   18.8% 20.0%  
Animal health 108 123 14.7% 284 298 4.8%
PBIT margin (%) 10.7% 20.9%   15.2% 13.4%  
Total revenues 1,383 1,487 7.6% 4,212 4,184 -0.7%
Total PBIT margin (%) 18.2% 20.8%   23.4% 21.0%  

Operating margins improve: Novartis’ operating margins expanded by 110 basis points during the quarter, largely due to a fall in raw material costs. Advertisement and selling expenses (as percentage of sales), however, increased during the quarter, which could be attributed to the promotion of its brands in the OTC segment. Given the fact that Novartis sources its products from third-party manufacturers, purchase of finished goods (as percentage of sales) witnessed a rise. We expect margins to expand going forward, backed by an improved product mix in both its pharmaceuticals and OTC businesses

Cost break-up
(% sales) 3QFY06 3QFY07 9mFY06 9mFY07
(Increase)/ decrease in stock 3.0% -0.8% 2.9% 2.5%
Raw material consumption 2.4% 3.7% 1.8% 3.8%
Staff cost 9.9% 10.3% 8.9% 9.9%
Purchase of finished goods 40.9% 41.5% 44.4% 38.4%
Advertisement and sales promotion 9.4% 9.9% 6.8% 8.6%
Other expenditure 18.8% 18.8% 17.6% 19.1%

‘Extraordinary’ impact: Despite a 19% YoY growth in PBT, net profits declined by 9% YoY during the quarter largely owing to a higher tax outgo. Even a 26% YoY growth in other income could do nothing to prop the bottomline.

Quarterly trend
(%) 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07
Net sales growth -2.1% 2.3% 32.4% -12.4% 5.4% 7.6%
Operating profit margin 7.3% 15.5% 11.5% 20.7% 15.5% 16.6%
Net profit margin 22.4% 16.7% 19.1% 18.3% 13.8% 14.2%

What to expect?
At the current price of Rs 367, the stock is trading at a price to earnings multiple of 11.2 our estimated FY08 earnings. Going forward, the pharmaceutical and OTC businesses are expected to be the key growth drivers, which will largely be driven by new product launches. With the advent of the product patent law in India, Novartis has unveiled plans to launch patented products in India from 2007 onwards. Having said that, we expect the generics segment to witness pressure going forward owing to the difficult pricing environment in the anti-TB segment. Given the company’s poor performance during 9mFY07, we shall have to downgrade our estimates for the full year.

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