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Novartis: Headed where? - Views on News from Equitymaster
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Novartis: Headed where?
Jun 22, 2005

With the patent regime now in force in India, as an MNC company, Novartis has a lot to gain in terms of new product launches. However, it will continue to face severe competition from its more established peers such as Glaxo and Aventis. In this article, we take a look at how the company has performed in the previous years and what lies in store for the future.

Company background
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 back up which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has a no manufacturing operations in India and all the products that Novartis sells are either out-sourced from the local producer or imported from the parent company. Thus, Novartis should be seen as a trading company rather than a drug manufacturing company. This puts a question mark on the company’s seriousness about the Indian market.

How the numbers stack up...
(%) FY01 FY02 FY03 FY04 FY05 CAGR (%)
Net sales growth   6.7% 0.9% 7.0% -6.6% 1.8%
Operating profit margin 12.2% 13.9% 13.0% 14.6% 15.0%  
Net profit margin 9.6% 13.9% 13.1% 22.5% 13.8%  
Net profit growth   55.6% -4.9% 83.4% -42.7% 11.6%

The journey over the years
Volatility in revenues:  The revenues of the company from the period FY01 to FY05 have shown signs of volatility and have grown at a CAGR of 2%. While FY02 registered a decent 7% YoY growth each on account of better price realisations, FY04 recorded a YoY growth rate of 7% too. However, this growth rate (FY04) was lower than the 7.3% rate at which the pharma industry had grown in the same year. This underperformance from Novartis could be attributed to the absence of new product launches. VAT related concerns, which led to de-stocking at the retailers’ level, had an adverse effect on FY03 and FY05 revenues. The impact was more severe in FY05, where revenues actually declined by 7% YoY.

Operating margins and profitability:  Though the operating margins have expanded over the years, albeit marginally, they have been under pressure owing to higher staff costs (VRS expenditure) and increasing purchase of traded goods, which was more apparent in FY05 (as mentioned earlier, the company is a trading company rather than a drug manufacturing company).

As far as net profits are concerned, the company again has not been able to remain consistent. To be more specific, in FY02, net profits recorded a 56% YoY growth on the back of increased revenues and lower interest costs owing to liquidation of debt. FY03 saw a 5% YoY decline in profitability due to reduced sales, adverse exchange rate movements and higher depreciation charges. Similarly, while the profitability jumped 83% YoY in FY04 chiefly due to reversal of wealth tax provisions, it once again declined in FY05 due to lower other income and higher tax outgo.

Segmental performance:  If one were to look at the segmental performance, then the picture has been varied over the years.

    Segmental revenue growth
    (%) FY02 FY03 FY04 FY05
    Pharmaceuticals 7.4% 9.5% 6.2% -6.9%
    Generics 0.0% -14.4% 9.9% -7.2%
    Over the Counter (OTC) 10.7% -2.5% 17.1% 9.7%
    Animal health 19.2% 8.1% -4.0% -23.3%
  • Pharmaceuticals:  This segment contributed 61% to sales (FY05). However, it has been facing pressure lately, which was more evident in FY05 when it witnessed a decline of 7% YoY in revenues. In the previous 3 years, the performance was much better, as it clocked YoY growth rates in the range of 6% to 9%. While margins have been affected due to various factors such as lower sales from certain therapeutic areas and adverse exchange rate movements, contribution from new products introduced over the years and better price realisations have helped maintain the growth rates.

  • Generics:  This division, which contributed 22% to sales (FY05), has been under pressure over the years due to the poor performance of its anti-TB product range, which continued to be adversely impacted by falling prices. In fact, the bulk drugs business of ‘Rifampicin’ faced severe operational challenges owing to surplus capacities, cheaper imports and falling domestic prices. As a result, the company sold the unviable ‘Rifampicin’ business in FY05. FY04 was the only year when the company posted a decent 10% YoY growth in this segment. However, this was primarily owing to the company being awarded the World Bank funded tender for supply of anti-TB products.

  • OTC:  Though the OTC (over the counter) segment contributed only 11% to sales (FY05), it has posted robust growth rates over the years aided by its leading and very popular brand, ‘Calcium Sandoz’. FY03 is the only year when this segment’s revenues declined by 3% YoY on account of VAT related concerns.

  • Animal health:  While the animal health segment has shown good growth in revenues in FY02 and FY03 on account of intensive marketing efforts and rural penetration programs in the cattle and poultry segments, FY04 faced the brunt of drought in various parts of the country and the adverse impact of bird flu. FY05 revenues were also affected due to the discontinuation of a certain compound. However, the margins of this segment have consistently been under pressure due to competition from generics.

Peer comparison
(%) Novartis* Glaxo** Aventis** Pfizer***
Net sales growth -6.6% 25.9% 12.8% 17.5%
Operating profit margin 15.0% 28.0% 29.2% 11.8%
Net profit margin 13.8% 24.2% 20.2% 8.2%
* Year ended March 2005   ** Year ended Dec 2004   *** Year ended Nov 2004

What to expect?
At Rs 510, the stock is trading at a price to earnings multiple of 25.1 times FY05 earnings. As mentioned earlier, the company recently sold its ‘Rifampicin’ business, which is expected to increase operational efficiency going forward. Historically, the valuations of this company have been at a discount to its MNC peers like Glaxo (currently trading at price to earnings of 36.4 times 1QCY05 earnings) for reasons such as lower penetration in the markets and absence of manufacturing activity. Having said that, initiatives taken to increase penetration in Tier 2 and Tier 3 markets (smaller towns) are likely to augur well for the company. Also, with the new patent regime the company will be in position to launch new-patented products in the Indian markets giving it a further boost. However, till that time, Novartis will be seen as a trading company and will get a lower valuation compared to top MNC pharma companies.

Though the performance of Novartis has been subdued in FY05 and is likely to continue so in FY06, we believe that the company is likely to regroup in FY07, as it makes significant product launches. Also, with the advent of the patent regime, the parent company Novartis AG cannot afford to lose focus on the Indian markets. That will be the guiding light for investors over the long term.

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