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Pfizer: VAT hits but margins zip

Mar 31, 2005

Performance Summary
Pfizer India declared its first quarter numbers for the period ended February 2005 yesterday. The company reported nearly 3% dip in revenues during the quarter, largely due to the de-stocking at the wholesalers level in view of the proposed VAT implementation from April 1, 2005. The company had reported a 4% revenue growth (standalone basis) during the November quarter. However, profitability improvement continued in the February quarter and this helped the company report an encouraging 30% growth in bottomline despite revenue sluggishness.

(Rs m) 1Q04 1Q05 Change Nov'04 Change
Net Sales 1,369 1,329 -2.9% 5,578 17.5%
Expenditure 1,199 1,101 -8.2% 4,919 11.6%
Operating Profit (EBDITA) 170 228 34.4% 659 95.2%
EBDITA margin (%) 12.4% 17.2% 11.8%
Other income 83 87 5.8% 392 -3.2%
Interest 2 2 -37.5% 8 107.7%
Depreciation 19 29 52.3% 103 -5.3%
Profit before Tax 231 285 23.4% 941 49.2%
Tax 76 92 20.9% 293 55.9%
Extraordinary income /(expense) (52) (58) 12.5% (192) 14.9%
Profit after Tax 103 135 30.8% 455 65.5%
Net profit margin (%) 7.5% 10.1% 8.2%
Effective tax rate (%) 32.8% 32.2% 31.2%
No. of Shares (m) 29.8 29.8 29.8
Diluted Earnings per share (Rs)* 13.8 18.0 15.3
Price to earnings ratio (x) 39.1
(* annualised), All figures are consolidated numbers of Pfizer plus Pharmacia Healthcare

What's 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 (a cough syrup) and Becosules (a B-complex supplement), both being more than Rs 1 bn brands each. The company has merged Parke Davis and Pharmacia with itself. Pfizer derives most of its revenues from the pharmaceuticals division (86%). The company also has presence in the animal health (10%) and clinical development operations (4%) segments. In the pharma segment, merger with Parke-Davis and strong brands like Benadryl, Corex and Gelusil are the key drivers. In the animal health segment, Pfizer plans to capitalize on its parent's global leader status and become a major player. The company is also evaluating the inorganic growth strategy in this segment. Pfizer also carries out clinical trials on behalf of its parent.

What has driven performance in 1Q05?
The restructuring exercise initiated by the company in last two years seems to have started benefiting the company, which can be seen from the improved margins over the last 4 quarters.

Sales: The dip in the revenue performance of the company was largely led by its core business of pharmaceuticals (87% of revenues), which declined by over 4% during the quarter. As mentioned earlier, the company has attributed this to VAT concerns at wholesaler level. In our view, Pfizer continues to underperform other top rung peers, who have managed to consistently beat industry growth rates of 6%-8%.

However, Pfizer's clinical development services business continued its buoyant growth (up 69% YoY) during the quarter. The company had reported an equally buoyant 52% growth in this business in the previous quarter (November ending). The company's Animal Healthcare business (10% of revenues) too was sluggish, growing by only 1% in the quarter, as compared to a consistent 8%-9% growth during most of 2004.

Segmental snapshot
(Rs m) 1Q04 1Q05 Change Nov'04 Change Contribution to
Nov'04 revenues
PBIT contribution
(Nov'04)
Pharmaceuticals (incl. services) 1,248 1,193 -4.4% 5,041 16.7% 86.5% 95.1%
PBIT margin (%) 22.7% 24.9% 21.5%
Animal Health (incl. services) 140 141 1.1% 585 9.4% 10.0% 3.1%
PBIT margin (%) -1.1% 5.0% 6.1%
Services - Clinical
Development Operations
29 49 69.3% 203 8.4% 3.5% 1.8%
PBIT margin (%) 14.5% 11.0% 10.2%
Total revenues 1,416 1,383 -2.4% 5,830 15.6%
Total PBIT margin (%) 20.2% 22.4% 19.6%

Restructuring bearing fruit: Pfizer has benefited on the operational front, led by largely by lower raw material costs as a percentage of revenues and focus on efficiencies. We believe, the operating performance will improve further, as the benefits of restructuring continue to filter in. The restructuring has also involved the discontinuance of relatively non-profitable brands over a period of two years. Consequently, profitability of its pharmaceutical, as well as Animal Healthcare business is on an uptick.

Cost break-up
(as a % of sales) 1Q04 1Q05 Nov'04
Material consumption 31.1% 22.8% 26.2%
Purchase of finished goods 13.1% 15.1% 13.9%
Staff cost 14.3% 17.2% 14.8%
Other expenditure 29.0% 27.8% 33.3%
Total 87.6% 82.8% 88.2%

Over the last few quarters: There has been an inconsistency in Pfizer's performance over the last few quarters. While there was a spurt in sales growth in the first quarter of 2004 (low base effect), the overall performance till date has been modest, considering the fact that the products of the company are mostly old and competition is higher. Nevertheless, going forward, greater efficiencies on a consolidated basis will continue to reflect in operating margins (as seen in February 2005 quarter (1Q05).

What to expect?
At Rs 705, the Pfizer stock is trading at 39 times annualised 1Q05 earnings. Though valuations look on the higher side, one must remember that Pfizer is in a phase where growth in profits will be faster than its sales growth since full benefits of the restructuring are yet to reflect in margins. Apart from this, the new patent regime will bring in benefits in form of new product launches. The management has already indicated that they will look at launching 2 products a year. We believe that the company is set to aggressively explore this market opportunity, which is likely to contribute to a higher growth in the future.

It is clear that the companies' consolidated revenues will clock a CAGR of 10% to 11% of the next 2 years (till November 2006). We also anticipate operating margins to improve to over 15% on a sustainable basis. Based on this, it is advisable to ‘Hold' on to the stock. The update on Pfizer's Research Report will be available on Tuesday April 5, 2005.

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