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Novartis: A ray of light, at last!

Aug 3, 2005

Performance Summary
Novartis announced strong results for the first quarter ended June 2005. Growth in the topline was driven by a strong show of all its business segments, except generics. Efficiencies at the operating level leading to a considerable improvement in operating margins led to the strong bottomline growth during the quarter.

Financial performance: A snapshot
(Rs m) 1QFY05 1QFY06 Change
Net sales 1,318 1,601 21.5%
Expenditure 1,059 1,166 10.1%
Operating profit (EBDITA) 259 435 68.0%
EBDITA margin (%) 19.7% 27.2%  
Other income 66 86 30.3%
Interest (net) 1 1 0.0%
Depreciation 13 4 -69.2%
Profit before tax 311 516 65.9%
Tax 100 144 43.6%
Profit after tax/(loss) 211 372 76.6%
Net profit margin (%) 16.0% 23.2%  
No. of shares (m) 32.0 32.0  
Diluted earnings per share (Rs)* 26.3 46.5  
Price to earnings ratio (x)   12.2  
(* annualised)      

What is 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 segments. Also, it has a very strong parent backup, which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has no manufacturing operations in India and all the products that Novartis sells are either outsourced from a local producer or imported from the parent company. Thus, this company should be seen as a trading company rather than a drug manufacturing company.

What has driven performance in 1QFY06?
Revenues grow at a healthy pace: After a 23% YoY decline in revenues in the previous quarter (4QFY05) on account of reduced offtake from its retail distribution chain due to VAT uncertainties, Novartis staged a strong recovery in 1QFY06 clocking a 22% YoY revenue growth. As far as its segments are concerned, all, except generics, posted a healthy double-digit growth. While the OTC segment continued to log in a robust 45% growth, the chief contributor to the topline i.e. pharmaceuticals (73% of revenues) growing by 40% YoY was a big positive. The generics business continued to remain under pressure and declined 46% YoY on the back of the sale of its ‘Rifampicin’ bulk drug business and de-growth witnessed in the anti-TB business.

Segmental performance
(Rs m) 1QFY05 1QFY06 Change % contribution to
1QFY06 sales
Pharmaceutical 831 1,160 39.6% 72.5%
PBIT margin (%) 26.1% 31.8%    
Generics 280 152 -45.7% 9.5%
PBIT margin (%) 14.3% 48.7%    
OTC 142 206 45.1% 12.9%
PBIT margin (%) 10.6% 18.9%    
Animal health 65 83 27.7% 5.2%
PBIT margin (%) 18.5% 19.3%    
Total revenues 1,318 1,601    
Total PBIT margin (%) 21.5% 31.1%    

Sharp margin expansion: While margins remained largely under pressure in FY05, focus on improving efficiency at the operating level has augured well for Novartis in 1QFY06, wherein margins have expanded by an impressive 750 basis points. As can be seen from the table below, the company witnessed a reduction in almost all its expenses (as % of net sales). However, the focus of the company on trading activity was apparent during the quarter, which was reflected in an increase in the purchase of finished goods.

Cost break-up
(% sales) 1QFY05 1QFY06
(Increase)/ decrease in stock 5.0% 2.2%
Raw material consumption 4.8% 0.5%
Staff cost 9.3% 8.1%
Purchase of finished goods 37.8% 43.9%
Other expenditure 23.4% 18.2%

Bottomline surges: Robust topline growth, considerable improvement in operating margins along with a steep 69% YoY fall in the depreciation charges (attributed to the sale of the ‘Rifampicin’ bulk drug business together with its Mahad facility) led to the strong 77% YoY growth in bottomline.

Over the last few quarters: Novartis’ revenues have made a strong comeback this quarter after showing a declining trend over the previous few quarters, which is a positive sign. Further, with the exception of 4QFY05, wherein a sharp decline was witnessed primarily due to a combination of reduced sales and escalating costs, operating margins have been more or less stable.

What to expect?
At the current price of Rs. 568, the stock is trading at a price to earnings multiple of 12.2 times its annualised 1QFY06 earnings. The company recently sold its ‘Rifampicin’ business, which is expected to increase the operational efficiency going forward. Initiatives taken to increase penetration in Tier 2 and Tier 3 markets (smaller towns) are likely to augur well for the company. Also, with the new patent regime, the company will be in position to launch new-patented products from its parent’s portfolio in the Indian markets, which augurs well for the company’s topline. Novartis plans to launch new patented products in India from 2007 onwards. Having said that, with Novartis not planning to establish manufacturing facilities in India in the near future, it will be seen as a trading company and will get a lower valuation as compared to the top MNC pharma companies like Glaxo and Aventis.

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