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Novartis: A year to forget! - Views on News from Equitymaster
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Novartis: A year to forget!
May 29, 2007

Performance summary
Novartis announced subdued results for the fourth quarter and full year ended March 2007. While the pharmaceuticals and the OTC segment have contributed to the topline growth, the generics business continued to reel under pressure. Despite maintaining operating margins, bottomline witnessed a decline largely due to the impact of the extraordinary income received in FY06. Excluding this impact, the bottomline has grown by 12% YoY. The performance for the fourth quarter was, however, strong with both the topline and the bottomline growing in tandem at a healthy double-digit pace.

Financial performance: A snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 1,048 1,239 18.2% 5,259 5,422 3.1%
Expenditure 927 1,090 17.6% 4,398 4,537 3.2%
Operating profit (EBDITA) 121 148 22.8% 862 886 2.8%
EBDITA margin (%) 11.5% 12.0%   16.4% 16.3%  
Other income 168 208 23.9% 373 501 34.2%
Interest (net) 2 2 -9.1% 27 6 -76.2%
Depreciation 7 7 -1.5% 6 27 352.5%
Profit before tax 280 348 24.3% 1,202 1,354 12.6%
Tax 80 109 36.6% 410 468 14.1%
Extraordinary item - -   287 -  
Profit after tax/(loss) 200 239 19.4% 1,079 886 -17.9%
Net profit margin (%) 19.1% 19.3%   20.5% 16.3%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)*         27.7  
Price to earnings ratio (x)*         12.4  
(* 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 FY07?
Staid revenue growth: Revenues during the year grew by 3% YoY, which was largely driven by its pharmaceuticals (up 5% YoY) and OTC segments (up 10% YoY). Growth in revenues from the OTC segment was led by the consolidation of existing brands and new product launches. Revenues from the generics segment declined by 22% YoY during the year owing to its exit from the low margin tender business in the anti-TB segment and the downturn in the retail trade business. For the quarter, however, the strong 18% YoY topline growth was largely driven by the pharmaceuticals business, which reported an impressive 25% YoY growth.

Segmental performance
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Pharmaceuticals 769 960 24.8% 3,643 3,835 5.3%
PBIT margin (%) 29.8% 23.7%   25.1% 21.4%  
Generics 100 92 -7.5% 552 433 -21.5%
PBIT margin (%) 31.5% 6.1%   32.0% 27.2%  
OTC 119 125 5.6% 721 796 10.4%
PBIT margin (%) -16.2% -18.3%   13.0% 14.0%  
Animal health 60 62 2.5% 344 359 4.4%
PBIT margin (%) 5.5% -14.6%   13.5% 8.6%  
Total revenues 1,048 1,239 18.2% 5,259 5,422 3.1%
Total PBIT margin (%) 23.4% 16.3%   23.4% 19.9%  

Stable operating margins: Novartis’ operating margins remained stable at 16.3% during the year as the impact of the fall in purchase of finished goods (as percentage of sales) was negated by the rise in staff costs, advertisement expenses and other expenditure. We expect margins to expand going forward, backed by an improved product mix in both its pharmaceuticals and OTC businesses.

Cost break-up
(% sales) 4QFY06 4QFY07 FY06 FY07
(Increase)/ decrease in stock -13.9% -12.7% -0.4% -1.0%
Raw material consumption 3.2% 4.1% 2.1% 3.9%
Staff cost 13.6% 11.2% 9.8% 10.2%
Purchase of finished goods 57.7% 51.9% 47.0% 41.5%
Advertisement and sales promotion 7.6% 10.2% 6.9% 9.0%
Other expenditure 20.3% 23.3% 18.1% 20.1%

‘Extraordinary’ impact: Despite a 13% YoY growth in PBT, net profits declined by 18% YoY during the year largely due to the impact of the extraordinary income that the company received in FY06. Excluding the extraordinary item, the bottomline for the full year has grown by 12% YoY. Higher other income has also contributed to the 12% YoY growth in net profits.

Quarterly trend
(%) 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07
Net sales growth 2.3% 32.4% -12.4% 5.4% 7.6% 18.2%
Operating profit margin 15.5% 11.5% 20.7% 15.5% 16.6% 12.0%
Net profit margin 16.7% 19.1% 18.3% 13.8% 14.2% 19.3%

What to expect?
At the current price of Rs 342, the stock is trading at a price to earnings multiple of 10.6 our estimated FY09 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. We shall soon update our research report on the company.

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