Nicholas Piramal: The right formulation!

Performance summary

---

Nicholas Piramal announced strong results for the first quarter ended June 2005. While the growth in the topline was driven by exports and formulations growth in the domestic market, tight control over costs led to an expansion in operating margins. This coupled with a lower tax outgo aided the bottomline growth.

Financial performance: A snapshot

(Rs m)	1QFY05	1QFY06	Change
Net sales	3,465	3,771	8.8%
Expenditure	2,833	3,057	7.9%
Operating profit (EBDITA)	632	714	12.9%
EBDITA margin (%)	18.2%	18.9%
Other income	77	59	-23.1%
Interest (net)	23	44	92.2%
Depreciation	106	137	29.5%
Profit before tax	580	591	2.0%
Extraordinary item	-	(5)
Tax	93	45	-51.4%
Profit after tax/(loss)	487	546	12.2%
Net profit margin (%)	14.1%	14.5%
No. of shares (m)	190.0	190.0
Diluted earnings per share (Rs)*	10.3	11.5
Price to earnings ratio (x)		22.2
(* annualised)

What is the company's business?

---

Nicholas Piramal is one of the leading Indian pharma companies with strong focus in the domestic market. It is the 4th largest company with 4.3% market share (FY05) in the domestic market with a large sales force covering 10 therapeutic segments of the pharma industry. The company has started focusing on the exports market too and the contribution of exports in total sales has increased to 12% from zero in the space of three years. It has gradually improved its product portfolio by increasing the share of lifestyle drugs and has also started focusing on R&D off late. The biggest contributor to company's revenue is the respiratory and cardiovascular segment. The other major therapeutic segments in which the company operates are anti-infectives, nutritional and gastro intestinal.

What has driven performance in 1QFY06?

---

Formulations propel revenues: After a dismal performance in the previous quarter, wherein revenues were dented on account of VAT and MRP based excise related concerns, revenues recovered in 1QFY06 and posted a 9% YoY growth. The 6% YoY growth in domestic sales (86% of revenues in 1QFY06) aided the overall growth of the company. What propelled the growth further in overall revenues was the 49% YoY growth in exports, which constituted 14% of sales in 1QFY06 as compared to 12% of sales in FY05. It must be noted that the company had recently acquired Rhodia's global Inhalation Anaesthetics (IA) business, which was the main driver of the exports growth during the quarter.

Cost break-up (% of sales) 1QFY05 1QFY06 Raw material 44.1% 43.4% Staff cost 10.8% 9.7% Marketing & selling expenses 13.2% 13.1% R&D expenses 2.7% 3.5% Other expenditure 7.6% 6.3%

In the domestic market, formulations revenue (75% of domestic sales) of the company grew by almost 14% YoY, which is much higher than the industry growth (2.4%). Amongst formulations, the major growth drivers have been the lifestyle segments of cardiovascular (CVS), anti-diabetic, CNS and dermatology. As far as new launches during the quarter are concerned, the company launched 12 new products, constituting 1.3% of sales.

Improvement in operating margins: Operating margins expanded by 70 basis points owing to the fact that the company managed to reduce costs (as a percentage of sales) on all the fronts except R&D. The increased R&D expenditure could be attributed to the fact that the company's oncology molecule has entered Phase I clinical trials in Canada.

Lower tax aids bottomline: During the quarter, Nicholas has witnessed a steep rise in interest costs (up 92% YoY) and depreciation charges (up 30% YoY). To add to the woes, the other income during the quarter was lower by 23% YoY. However, improvement in operating margins coupled with significantly lower tax incidence has offset the above negatives resulting in a 12% YoY growth in bottomline.

Quarterly trends

(%)	1QFY05	2QFY05	3QFY05	4QFY05*	1QFY06
Net sales growth	15.9%	2.0%	9.0%	-31.0%	8.8%
Operating profit margin	18.1%	21.9%	16.6%	-9.2%	18.9%
Net profit growth	41.3%	7.0%	99.4%	-	12.2%

*Net loss in 4QFY05

Over the last few quarters: The company's revenue growth has been rather inconsistent, which could be attributed to the snapping of ties with Roche Diagnostics (an international pharma company) and VAT related concerns in 4QFY05. However, with the exception of 4QFY05, the company has managed to consistently maintain operating margins above 15%.

What to expect?

---

At the current price of Rs. 255, the stock is trading at a price to earnings multiple of 26.2 times our estimated FY07 earnings, which is rather rich. Contract manufacturing is going to be the growth driver for the company going forward. In this regard, the company secured 2 agreements (one with a Fortune 500 company and the other with Allergan Inc. USA). Also, negotiations are underway to secure 2 more such contracts. Post the product patent regime, the company has initiated steps on the R&D front with its oncology molecule commencing Phase I clinical trials in Canada. However, we believe that the company is unlikely to introduce any new patented products over the next 3-4 years.