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Pfizer: Raw material issues
Jul 3, 2007

Performance summary
  • Sales decline by 1% YoY during the quarter due to supply related issues of a raw material and poor performance of the consumer healthcare business.
  • Operating margins decline by 60 basis points (0.6%) due to increase in purchase of finished goods and other expenditure (as percentage of sales).
  • Bottomline reports a huge jump (up 618% YoY) largely led by the extraordinary gains received on the sale of its property at Chandigarh.

Financial performance: A snapshot
(Rs m) 2QCY06 2QCY07 Change 1HCY06 1HCY07 Change
Net sales 1,671 1,647 -1.4% 3,131 3,197 2.1%
Expenditure 1,302 1,295 -0.6% 2,406 2,471 2.7%
Operating profit (EBIDTA) 368 352 -4.4% 724 726 0.2%
Operating profit margin (%) 22.0% 21.4%   23.1% 22.7%  
Other income 109 174 59.4% 230 294 27.7%
Depreciation 32 30 -6.9% 63 57 -9.8%
Profit before tax 445 496 11.4% 891 963 8.1%
Exceptional items (expense) 60 2,711 4440.9% 2 2,685  
Tax 146 629 330.8% 285 787 176.2%
Profit after tax 359 2,578 618.2% 608 2,861 370.6%
Net profit margin (%) 21.5% 156.5%   19.4% 89.5%  
No. of shares (m) 29.8 29.8   29.8 29.8  
Diluted earnings per share (Rs)**         34.7  
P/E ratio (x)*         23.6  
(* on a trailing 12-month basis)
(** excluding extraordinary item)

What is 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, Becosules, Gelusil and Benadryl. Pfizer derives most of its revenues from the pharmaceuticals division (87%). The company also has presence in the animal health (9%) and clinical development operations (4%) segments. In the animal health segment, Pfizer plans to capitalise on its parent's global leader status and become a major player. Pfizer also carries out clinical trials on behalf of its parent.

What has driven performance in 2QCY07?
Topline woes: During 2QCY07, Pfizer’s topline declined by 1% YoY. The company has attributed this to the supply related issues of a raw material and the overall staid performance of the consumer healthcare business. As far its products are concerned, both ‘Corex’ and ‘Becosules’, which account for a large chunk of the total pharma revenues, reported a flat growth. Sales of ‘Corex’ were impacted due to shortage of codeine phosphate, a raw material, which is sourced from the government. Having said that, while there will be some pressure in the next quarter as well, the management expects the situation to improve going forward.

The three new products namely 'Viagra', 'Caduet' (cardiovascular) and ‘Lyrica’ (nerve pain) contributed around 1% to the total revenues. The consumer healthcare business, which accounts for 22% of the total revenues, has not yet been divested in India and the company expects the decision on the same to be finalised this year itself. We have factored in the sale of the consumer healthcare business in our estimates and thus expect the revenues to decline by 5% YoY for the full year.

Operating margin scenario: Pfizer’s operating margins declined marginally by 60 basis points, which was largely due to an increase in raw material costs. It must be noted that the company imports bulk of its key raw material requirements from China and since the Chinese companies have undertaken price increases, the same has resulted in a rise in raw material costs during the quarter. The company, however, managed to keep its staff costs under control. Going forward, we expect operating margins to improve backed by improved field force productivity and a better product mix.

Cost break-up
(% of sales) 2QCY06 2QCY07 1HCY06 1HCY07
Material consumption 22.1% 21.0% 17.9% 20.9%
Purchase of finished goods 15.8% 17.3% 17.6% 15.2%
Staff cost 15.2% 14.0% 16.0% 14.1%
Other expenditure 24.9% 26.3% 25.4% 27.1%

Bottomline outpaces topline: Pfizer’s bottomline jumped 618% YoY during the quarter, largely led by the extraordinary income that the company received on the sale of its property at Chandigarh. As a result, tax expenses also increased and included the tax on capital gains to the tune of Rs 460 m. Excluding the impact of the extraordinary item, the bottomline for the quarter has actually grown by a mere 9% YoY.

Quarterly trend
  1QCY06 2QCY06 3QCY06 4QCY06 1QCY07 2QCY07
Net sales growth (YoY change) 9.8% 23.8% 9.7% 1.8% 6.2% -1.4%
Operating profit margin (%) 24.3% 22.0% 22.8% 15.3% 24.1% 21.4%
Net profit growth (YoY change) 84.0% 132.0% 28.6% -2.1% 14.1% 618.2%

What to expect?
At the current price of Rs 820, the stock is trading at a price to earnings multiple of 17.3 times our estimated CY09 earnings. We expect operating margins to improve going forward on the back of a healthy topline performance backed by existing and new products and continued efficiency at the operating level. The company has already launched three blockbuster drugs from its parent’s product portfolio in the Indian markets and has unveiled plans of launching around 3 products going forward as well.

Investors should note that the parent company Pfizer Inc. had announced the global divesture of the Consumer Healthcare Business in June 2006 to Johnson & Johnson. Consequently, the global closure was fixed on December 20, 2006 except for few markets like India, where the process has been delayed. The Board of Directors of Pfizer Ltd. in India is still evaluating the impact of the same on the Indian operations and an outcome on the same is expected to come out in CY07 itself. Having said that, we have factored in the impact of the sale of this business in our estimates for the year. We maintain our positive view on the stock.

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