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Aventis: Mixed signals!

Jul 25, 2006

Performance summary
Aventis has announced mixed results for the second quarter and half year ended June 2006. While the topline growth has been staid, margins have also contracted during the quarter on the back of a rise in other expenditure. However, the bottomline has grown at a much faster clip than the topline due to an increase in other income and lower depreciation and tax outgo.

Financial performance: A snapshot
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Net sales 2,143 2,228 4.0% 3,884 4,233 9.0%
Expenditure 1,519 1,609 5.9% 2,865 3,112 8.6%
Operating profit (EBIDTA) 624 619 -0.8% 1,019 1,121 10.0%
EBDITA margin (%) 29.1% 27.8% 26.2% 26.5%
Other income 61 90 47.5% 135 176 30.4%
Depreciation 43 42 -2.3% 87 85 -2.3%
Interest - 1 - 1
Profit before tax 642 666 3.7% 1,067 1,211 13.5%
Tax 300 227 -24.3% 489 403 -17.6%
Profit after tax/(loss) 342 439 28.4% 578 808 39.8%
Net profit margin (%) 16.0% 19.7% 14.9% 19.1%
No. of shares (m) 23.0 23.0 23.0 23.0
Diluted earnings per share (Rs)* 73.1
Price to earnings ratio (x)* 19.0
(* on a trailing 12-month basis)

What is the company's business?
Aventis Pharma, the 50% subsidiary of Aventis SA, France, is the second largest pharma MNC in India with a turnover of over Rs 8.1 bn (CY05). It is the eighth largest player in India with a market share of 2.9%. Aventis has relatively few but very strong brands in the country. Domestic sales constituted 77% of total sales in 1HCY06 and exports constituted the remaining 23%. Over the years, Aventis has progressively transformed itself into a company catering to the chronic (diabetes, cardio vascular) and critical-care therapeutic segments. Apart from catering to the Indian markets, Aventis supplies bulk drugs to its parent. In CY04, the parent merged with another France based pharma company, Sanofi, thus making it part of one of the largest pharma companies in the world.

What has driven performance in 2QCY06?
Subdued revenue growth: During the quarter, Aventis' topline grew by a staid 4% YoY largely due to a 10% YoY decline in exports revenues. Domestic sales (77% of total sales) grew by 9% YoY, which could be attributed to the high base effect last year, which was due to re-stocking by retailers, post implementation of VAT from April 1, 2005.Besides this, the company's leading brands such as ‘Amaryl, ‘Cardace', ‘Clexane', ‘Frisium' and ‘Rabipur' also contributed to the growth in domestic revenues. For the half-year period, 16% YoY growth in domestic sales has contributed to the 9% YoY growth in overall topline and is in line with our estimates. However, exports revenues for the half year continued to be a laggard, declining by 10% YoY.

Higher other expenses dent margins: Operating margins contracted during the quarter, largely due to a rise in other expenditure as a percentage of sales. The company, however, managed to keep its raw material and staff costs under control. That said, we do not forsee any significant margin improvement and expect operating margins to remain under pressure going forward.

Cost break-up
(% of sales) 2QCY05 2QCY06 1HCY05 1HCY06
(Increase)/decrease in stock in trade 3.5% 3.4% -6.8% -3.8%
Raw material consumption 44.9% 43.1% 55.6% 51.5%
Staff cost 8.6% 8.8% 9.5% 8.8%
Other expenditure 13.9% 16.9% 15.5% 17.1%

Faster bottomline growth: Aventis' bottomline grew at a faster clip than the topline and clocked a decent 28% YoY growth during the quarter. This was largely due to a rise in other income (up 48% YoY) and a significant reduction in tax outgo. It must be noted that the effective tax rate reduced from 47% in 2QCY05 to 32% in 2QCY06. The higher other income and the lower tax outgo also contributed to the robust 40% YoY bottomline in 1HCY06.

Over the last few quarters: There has been volatility in Aventis' revenues in the past few quarters due to the VAT effect and pressure on export revenues. On the operational front, though the company has managed to maintain operating margins above the 25% levels, we expect the same to be under pressure going forward. This is due to the fact that the company will not benefit anymore from the restructuring exercise that had helped expand margins in CY04.

Quarterly trend
(%) 1QCY05 2QCY05 3QCY05 4QCY05 1QCY06 2QCY06
Net sales growth 3.8% 15.8% 21.5% -1.2% 15.2% 4.0%
Operating profit margin 26.9% 29.1% 32.1% 25.7% 25.0% 27.8%
Net profit growth -26.3% 2.4% 16.9% -7.4% 56.4% 28.4%

What to expect?
At the current price of Rs 1,390, the stock is trading at a price to earnings multiple of 16.3 times our estimated CY07 earnings. In the domestic market, Aventis' strong presence in the fast-growing lifestyle segment along with its focus on strategic brands is expected to be the key growth driver going forward. The company, so far, has also been aggressive in launching new products and is therefore likely to be a major beneficiary in the patent regime when a slew of new products will be unveiled for the Indian markets. The company has undertaken several brand awareness initiatives over the years, which will augur well in terms of increased visibility for its products. However, the same is expected to pressurise margins going forward. We maintain our positive view on the stock.

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