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Aventis: Cost pressures evident - Views on News from Equitymaster

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Aventis: Cost pressures evident
Mar 29, 2007

Performance summary
Aventis has announced mixed results for the fourth quarter and year ended December 2006. While increase in revenues from the domestic market has largely driven the topline growth, revival in the international markets, especially in the fourth quarter, cushioned any further fall in exports for the full year. Operating margins have contracted owing to rise in raw material costs and other expenditure, the impact of which was more pronounced in the fourth quarter. A higher other income and a lower tax outgo have led to the bottomline growing at a faster pace than the topline for CY06.

Financial performance: A snapshot
(Rs m) 4QCY05 4QCY06 Change CY05 CY06 Change
Net sales 1,957 2,176 11.2% 8,078 8,840 9.4%
Expenditure 1,454 1,749 20.3% 5,837 6,633 13.6%
Operating profit (EBIDTA) 503 427 -15.1% 2,241 2,207 -1.5%
EBDITA margin (%) 25.7% 19.6%   27.7% 25.0%  
Other income 82 111 35.4% 295 471 59.7%
Depreciation 42 51 21.4% 172 179 4.1%
Interest - 1   - 2  
Profit before tax 543 486 -10.5% 2,364 2,497 5.6%
Tax 167 139 -16.8% 913 804 -11.9%
Profit after tax/(loss) 376 347 -7.7% 1,451 1,693 16.7%
Net profit margin (%) 19.2% 15.9%   18.0% 19.2%  
No. of shares (m) 23.0 23.0   23.0 23.0  
Diluted earnings per share (Rs)*         73.6  
Price to earnings ratio (x)*         16.6  
(* on a trailing 12-month basis)

What is the company’s business?
Aventis Pharma, the 50% subsidiary of Aventis SA, France, is the second largest pharma MNC in India. It is the eighth largest player in India with a market share of 2.9%. Aventis has relatively few but very strong brands in the country. Domestic sales constituted 74.5% of total sales in CY06 and exports constituted the remaining 25.5%. Over the years, Aventis has progressively transformed itself into a company catering to the chronic (diabetes, cardio vascular) and critical-care therapeutic segments. Apart from catering to the Indian markets, Aventis supplies bulk drugs to its parent. In CY04, the parent merged with another France based pharma company, Sanofi, thus making it part of one of the largest pharma companies in the world.

What has driven performance in CY06?
Recovery in exports: During the year, Aventis’ topline grew by 9% YoY, largely driven by its domestic revenues, which were up 14% YoY. The strong growth in domestic sales can be attributed to the growth in revenues of the company’s leading brands such as ‘Amaryl’, ‘Cardace’, ‘Clexane’, ‘Frisium’ and ‘Rabipur’, which cater to the cardiovascular, oncology and vaccines therapeutic areas. Exports for the full year fell by a marginal 1% YoY, This was largely due to the recovery in this segment during the fourth quarter, which saw the export sales grow by a robust 25% YoY (during 4QCY06). Given the fact that for 9mCY06, exports had actually declined by 10% YoY, the strong performance of the same in the fourth quarter is an encouraging sign. We expect exports to pick up pace going forward.

Revenue break-up
(Rs m) 4QCY05 4QCY06 Change CY05 CY06 Change
Domestic sales 1,446 1,540 6.5% 5,791 6,582 13.7%
Export sales 511 636 24.5% 2,287 2,258 -1.3%
Total 1,957 2,176 11.2% 8,078 8,840 9.4%

Margin pressure continues: Operating margins contracted by 270 basis points during CY06, largely due to a rise in other expenditure and raw material costs (as percentage of sales). The fall in the operating margins was more severe in the fourth quarter. The company, however, managed to keep its staff costs under control. Going forward, we do not forsee any significant margin improvement and expect operating margins to remain under pressure.

Cost break-up
(% of sales) 4QCY05 4QCY06 CY05 CY06
(Increase)/decrease in stock in trade -1.3% 2.4% -4.3% -2.5%
Raw material consumption 47.3% 48.7% 51.5% 51.0%
Staff cost 9.7% 9.6% 9.1% 8.9%
Other expenditure 18.7% 19.7% 16.0% 17.7%

In line with the topline: Aventis’ bottomline growth at 17% YoY during CY06 outpaced the topline growth largely owing to a 60% YoY growth in other income and a lower tax outgo. It must be noted that the effective tax rate reduced from 39% in CY05 to 32% in CY06.

Over the last few quarters: There has been volatility in Aventis’ revenues in the past few quarters despite its strong performance in the domestic market largely due to pressure on export revenues. On the operational front, the company has been facing pressure on operating margins and we do not forsee this scenario to ease going forward. This is due to the fact that the company will not benefit anymore from the restructuring exercise that had helped expand margins in CY04.

Quarterly trend
(%) 3QCY05 4QCY05 1QCY06 2QCY06 3QCY06 4QCY06
Net sales growth 21.5% -1.2% 15.2% 4.0% 8.7% 11.2%
Operating profit margin 32.1% 25.7% 25.0% 27.8% 28.3% 19.6%
Net profit growth 16.9% -7.4% 56.4% 28.4% 8.2% -7.7%

What to expect?
At the current price of Rs 1,220, the stock is trading at a price to earnings multiple of 13 times our estimated CY08 earnings. In the domestic market, Aventis’ strong presence in the fast-growing lifestyle segment along with its focus on strategic brands are expected to be the key growth drivers going forward. The company, so far, has also been aggressive in launching new products and is therefore likely to be a major beneficiary now that the product patent regime has come into force. The company has undertaken several brand awareness initiatives over the years, which will augur well in terms of increased visibility for its products. Having said that, we expect the pressure on margins to continue going forward. Investors should note that while the topline performance is in line with our estimates, the fall in operating margins for the full year has been higher than what we have estimated and hence we shall have to downgrade our operating margins estimate for the full year. We shall soon update our research report on the company.

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