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Novartis: All round performance! - Views on News from Equitymaster

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Novartis: All round performance!
May 19, 2006

Performance summary
Novartis has announced strong results for the fourth quarter and year ended March 2006. For the fiscal, growth in topline was driven by three of its four businesses namely, pharmaceuticals, OTC and animal health. The generics business, however, witnessed a decline in revenues. This, along with the improvement in operating margins and the impact of extraordinary items, propelled a healthy growth in bottomline. The company witnessed a superlative growth in topline and bottomline during 4QFY06.

Financial performance: A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 791 1,048 32.4% 4,715 5,259 11.5%
Expenditure 882 927 5.0% 4,009 4,398 9.7%
Operating profit (EBDITA) (91) 121   706 862 22.0%
EBDITA margin (%) -11.5% 11.5%   15.0% 16.4%  
Other income 184 168 -9.0% 380 373 -1.8%
Interest (net) 13 2 -82.7% 17 27 52.3%
Depreciation 13 7 -48.1% 52 6  
Profit before tax 67 280 315.5% 1,041 1,489 43.1%
Extraordinary item       24 287 1110.1%%
Tax 63 80 27.1% 389 410 5.4%
Profit after tax/(loss) 5 200 4245.7% 651 1,079 65.7%
Net profit margin (%) 0.6% 19.1%   13.8% 20.5%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)*         33.7  
Price to earnings ratio (x)*         14.6  
(* 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 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 FY06?
Robust topline growth: Novartis’ topline clocked a decent 12% YoY growth during FY06. This was led by strong performances of its pharmaceuticals, OTC and animal health business. Revenues from the pharmaceuticals business (69% of total revenues) were up 26% YoY, which was attributed to sustained and successful marketing and sales initiatives. It should also be noted that growth for this segment is buoyed due to the low base effect, as VAT related issues had negatively impacted performance in FY05. The OTC segment (14% of total revenues) reported a 38% YoY growth during the fiscal, backed by consolidation of its brands and launch of new products and line extensions. As regards the animal health business, revenues grew by 19% YoY led by a range of cattle products and a series of rural penetration programs undertaken by the company.

However, the generics segment has proved to be a dampener for Novartis during the fiscal. It must be noted that, during the year, the company had sold its unviable ‘Rifampicin’ business and, to that extent, the figures of the generics business are not comparable. However, even after excluding the sale of the ‘Rifampicin’ business, revenue from this segment has declined by 13% YoY due to a downturn in the retail trade business.

Segmental performance
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Pharmaceutical 460 769 67.4% 2,890 3,643 26.0%
PBIT margin (%) 3.2% 21.4%   22.6% 25.1%  
Generics 204 100 -51.2% 1,015 552 -45.7%
PBIT margin (%) -7.3% 39.5%   10.6% 32.0%  
OTC 80 119 49.1% 521 721 38.4%
PBIT margin (%) -47.3% 13.9%   5.6% 13.0%  
Animal health 48 60 26.5% 289 344 19.0%
PBIT margin (%) -14.1% 26.1%   13.2% 13.5%  
Total revenues 791 1,048 32.4% 4,715 5,259  
Total PBIT margin (%) -5.7% 23.4%   17.6% 23.4%  

Lower input costs aid margins: Operating margins expanded by 140 basis points during Fy06, which was largely due to a reduction in raw material costs and other expenditure (as a percentage of sales). However, Novartis’ focus on trading activity during the year was reflected by the increase in the purchase of finished goods (up 160 basis points as % of sales). Staff costs also increased during FY06, which was attributed to the payments of Rs 13.6 m made to employees under the VRS.

Cost break-up
(% sales) 4QFY05 4QFY06 FY05 FY06
(Increase)/ decrease in stock -29.3% -13.9% -3.1% -0.4%
Raw material consumption 7.4% 3.2% 5.3% 2.1%
Staff cost 14.9% 13.6% 9.7% 9.8%
Purchase of finished goods 77.8% 57.7% 45.4% 47.0%
Other expenditure 40.8% 27.9% 27.7% 25.1%

Bottomline bloats: The 66% YoY growth in the bottomline during the year was due to a considerable reduction in depreciation charges and the impact of extraordinary income. During the year, the company had changed its method of depreciation from Written Down Value (WDV) to Straight Line Method (SLM). As a result, the surplus depreciation of the earlier years was offset against the depreciation of the current year. Also, the company received extraordinary income from the sale of its Goregaon property, sale of its Rifampicin business and the insurance claims towards the damage of inventory during the July 2005 floods. If one excludes this extraordinary effect, then the bottomline has registered a 26% YoY growth.

Quarterly trend
(%) 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06
Net sales growth -7.0% -22.7% 21.5% -2.1% 2.3% 32.4%
Operating profit margin 21.6% -11.5% 27.2% 7.3% 15.5% 11.5%
Net profit margin 16.1% 0.6% 23.2% 22.4% 16.7% 19.1%

What to expect?
At the current price of Rs 491, the stock is trading at a price to earnings multiple of 18.3 times our estimated FY08 earnings. The disposal of the ‘Rifampicin’ business (having lower margins) is a step in the right direction and margins are likely to improve. Initiatives taken to increase penetration in Tier-2 and Tier-3 markets (smaller towns) are likely to augur well for the company. The pharmaceutical and OTC businesses are expected to be the key drivers.

Also, with the new patent regime in place, the company is in a position to launch new-patented products from its parent’s portfolio in the Indian markets, which will boost the topline. Novartis plans to launch patented products in India from 2007 onwards. Having said that, the generics business is likely to witness pressure going forward owing to shrinkage in the anti-TB segment. Having said that, the topline numbers are above our estimates and we will have to upgrade our numbers accordingly. We shall soon update our research report on the company.

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