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Novartis: Not very exciting

Jul 23, 2004

Introduction to results
MNC pharma company, Novartis India, declared its 1QFY05 results yesterday. The topline of the company has declined marginally, while the bottomline has grown 20% on back of gains on operational front. The operating profit margin stood at 19.7% compared to 13.8% in the same quarter last year.

(Rs m) 1QFY04 1QFY05 Change
Net sales 1,328 1,318 -0.7%
Other income 81 66 -18.3%
Expenditure 1,144 1,059 -7.4%
Operating profit (EBDITA) 184 259 41.4%
Operating profit margin (%) 13.8% 19.7%  
Interest 2 1 -33.3%
Depreciation 38 13 -66.1%
Exceptional Items - -  
Profit before tax 225 312 38.6%
Tax 48 100 107.2%
Profit after tax/(loss) 176 211 19.8%
Net profit margin (%) 13.3% 16.0%  
No. of shares (m) 32.0 32.0  
Diluted earnings per share (Rs)* 22.1 26.4  
P/E ratio (x)   16.8  
(* annualised)      

What's 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 segment. 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, this company should be seen as a trading company rather than a drugs manufacturing company. This puts a question mark on the company's seriousness about the Indian market.

What has driven performance in 1QFY05?
Sales:  The sales of the company are marginally down on back of poor performance in both the pharma segment and animal healthcare segment. The sales in the animal health care segment fell by 52% due to discontinuation of one of the drugs 'organophosphorus'. However, the generics segment of the company grew by almost 14% due to a big one-time order of Rs 53 m. Excluding this, the generics business actually declined by 8% YoY. OTC segment grew by 6.3%, which can be attributed to company's strong focus on this area, which is likely to continue going forward. The growth in the pharmaceutical segment seems to be marred by the reduction in prices of TB drugs. However, the company is now targeting tier II / tier III cities and towns in the country to expand geographically. This initiative, though time consuming, will improve company's revenue growth going forward.

Segmental revenue share
  1QFY04 1QFY05 Change % of Sales 1QFY04 % of Sales 1QFY05
Pharmaceutical 810 831 2.6% 61.0% 63.1%
Generics 248 280 13.2% 18.7% 21.3%
OTC 134 142 6.3% 10.1% 10.8%
Animal Health 136 65 -52.4% 10.2% 4.9%
Total 1,328 1,318 -0.7% 100.0% 100.0%

Operating margins:  Despite the decline in topline, the operating margins have improved. This could be attributed to better sales mix. The raw material costs have come down significantly in the quarter and also the costs involved in the purchase of trading goods have also come down. The staff cost has come down by 2%. However, if one excludes the cost of VRS from 1QFY04 number, the staff cost has actually gone up by 6% YoY. It seems that the change in inventory valuation method has also increased the margins of the company, since it has decreased the value of raw material consumed.

Cost break-up
  1QFY04 1QFY05 Change % of Sales 1QFY04 % of Sales 1QFY05
Raw Material 174 130 -25.5% 13.1% 9.8%
Staff Cost 124 122 -1.8% 9.4% 9.3%
Purchase of Traded Goods 546 498 -8.9% 41.1% 37.8%
Other Expenditure 300 309 3.2% 22.6% 23.5%
Total 1,144 1,059 -7.5% 86.2% 80.3%

Net profit:  On back of better operational performance and lower depreciation charge (due to hiving-off of a generics unit) the net profit of the company has grown by 20%. Higher tax outgo however, kept this growth in check.

What to expect?
At Rs 445, the stock is trading at 16.8x its annualised 1QFY05 earnings. Novartis is a leading multinational pharma company with some strong brands. The valuations have been at a discount to its peers for reasons mentioned above and lack of new product introductions. The company's future growth depends upon the actions taken by the government on the Patent bill, an amendment to which is pending in the parliament. If the bill is passed, it will prove to be a great boost for the company, considering the fact that its parent has a strong pipeline of innovative drugs. Till such time, Novartis will continue to be viewed and therefore valued as a trading company.

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