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Wockhardt: Investing for the future - Views on News from Equitymaster
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Wockhardt: Investing for the future
Jul 28, 2006

Performance summary
Wockhardt has announced subdued results for the second quarter and half year ended June 2006. While topline has recorded a staid 9% YoY growth during the quarter, largely driven by its revenues from the domestic and UK businesses, operating margins have contracted due to a significant rise in R&D expenditure. Reduction in other income coupled with higher depreciation charges has led to the 18% YoY decline in bottomline.

Consolidated numbers
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Net sales 3,771 4,127 9.4% 6,867 7,637 11.2%
Expenditure 2,809 3,230 15.0% 5,306 6,051 14.0%
Operating profit (EBIDTA) 962 897 -6.8% 1,561 1,586 1.6%
Operating profit margin (%) 25.5% 21.7%   22.7% 20.8%  
Other income 34 18 -47.1% 124 51 -58.9%
Interest 46 (6)   105 (84) -180.0%
Depreciation 107 140 30.8% 210 277 31.9%
Profit before tax 843 781 -7.4% 1,370 1,444 5.4%
Extraordinary item - -   - (604)  
Tax 67 147 119.4% 179 242 35.2%
Profit after tax/ (loss) 776 634 -18.3% 1,191 598 -49.8%
Net profit margin (%) 20.6% 15.4%   17.3% 7.8%  
No. of shares (m) 109.2 109.4   109.2 109.4  
Diluted earnings per share (Rs)*         18.1  
P/E ratio (x)*         19.0  
(* on a trailing 12-month basis)

What is the company’s business?
Wockhardt Ltd, a subsidiary of Khorakiwala Holdings and Investments Pvt. Ltd (75% stake), is one of the leading domestic pharmaceutical companies with strong presence in the lifestyle segment and a growing focus on biotechnology. With acquisitions in the international markets, the company has demonstrated its growing global ambitions. During CY05, Wockhardt derived 63% of its revenues from non-India regions (60% in CY04). Wockhardt has a subsidiary in the UK, which holds 100% in CP Pharma and Wallis Laboratories. The company has acquired ‘Esparma GmbH’ in Germany and has set up presence in Brazil and the US. The company spent about 5% of consolidated revenues on R&D in CY05 and has proven its R&D capabilities by indigenously developing and launching Biovac-B (Hepatitis-B vaccine), Wepox (Erythropotein) and Wosulin (human insulin).

What has driven performance in 2QCY06?
India shines: Wockhardt’s domestic business registered a decent 11% YoY and a 26% YoY growth in 2QCY06 and 1HCY06 respectively. The growth was driven by impressive performances of its key businesses – diabetology (up 41% YoY in 1HCY06) and nephrology (up 46% YoY). Going forward, the company plans to increase its presence in the market by launching new products and has in-license products through co-marketing agreements.

Geographical mix
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
India 1,569 1,742 11.0% 2,462 3,091 25.5%
Europe 1,425 1,653 16.0% 2,796 2,948 5.4%
US 404 380 -5.9% 772 809 4.8%
Rest of the world (ROW) 373 351 -5.9% 837 788 -5.9%
Total 3,771 4,126 9.4% 6,867 7,636 11.2%

US – Poor show: Revenues from the US business declined by 6% YoY during the quarter. This was attributed to the transition partner product distribution agreement to the company’s own sales and distribution network, consequently affecting sales. It must be noted that some of Wockhardt’s products were being marketed by Ranbaxy in the US markets. That said, the US business is expected to pick up pace going forward with an increase in product approvals. During the quarter, Wockhardt received 4 US FDA approvals, out of which one approval was for an injectable. As of date, the company has 20 ANDAs awaiting approval with the US FDA.

Business mix
  2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Formulations 3,386 3,731 10.2% 6,033 6,817 13.0%
Bulk drugs 385 395 2.6% 835 819 -1.9%
Total 3,771 4,126 9.4% 6,868 7,636 11.2%

Europe leads the way: Europe was the strongest performer during the quarter, clocking a 16% YoY revenue growth. This performance was primarily contributed by the UK region, which witnessed a 19% YoY growth in revenues. Driving sales in this region were new product launches, which included 4 injectable products in oncology and 1 injectable product in cardiology. The company also launched ‘Ondansteron’ injections (GSK Plc’s ‘Zofran’) on Day 1 in the market. The German business, however, declined by 2% YoY largely impacted by the change in healthcare reforms in the country. This has affected most of the Indian pharma companies operating in the German market. Going forward, launch of new products in these two markets is expected to drive growth.

R&D dents margins: Operating margins contracted by 380 basis points during the quarter largely due to a significant 77% YoY rise in R&D expenditure. With its biotech park being commercially operational, staff costs and other expenses also witnessed a considerable rise.

Cost break-up
  1QCY05 1QCY06 1HCY05 1HCY06
(Increase)/decrease in stock 0.9% 1.1% 1.9% -3.6%
Raw material consumption 26.9% 23.0% 25.3% 26.3%
Purchase of finished goods 15.4% 14.0% 15.5% 14.8%
Staff cost 11.5% 13.6% 12.9% 14.6%
R&D expenditure 4.1% 6.6% 4.7% 6.6%
Other expenditure 15.7% 19.9% 17.0% 20.6%

Bottomline is hampered: Bottomline declined by 18% YoY during the quarter, impacted by the staid topline growth and fall in operating profits. A higher tax outgo, which was attributed to the increase in MAT rates, also contributed to the net profits decline.

Quarterly trend
(%) 1QCY05 2QCY05 3QCY05 4QCY05 1QCY06* 2QCY06
Sales growth (YoY) 6.5% 28.8% 12.0% 5.4% 13.4% 9.4%
Operating profit margin 19.3% 25.4% 24.3% 23.3% 19.6% 21.7%
Net profit growth (YoY) -6.1% 54.7% 16.5% 15.7% - -18.3%
* Net loss during the quarter

What to expect?
At the current price of Rs 344, the stock is trading at a price to earnings multiple of 11.9 times our estimated CY07 earnings. In the domestic market, biopharmaceuticals and in-licensing will be the key growth drivers for Wockhardt going forward. The company’s strategy in the domestic market is to increase market reach and penetration of existing products and focus on new product launches through the in-licensing route. In the US market, the company's focus on injectables will be the key as this field has relatively lesser competition due to the complex technology involved and high level of investment required. That said, pricing pressure in the US, UK and recently the German markets would continue to remain cause for concern.

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