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Novartis: The poor show continues

Aug 9, 2007

Performance summary
  • Revenues fall by 1% YoY due to the 6% YoY decline in the revenues from the pharma business (69% of total sales)

  • EBDITA margins contract by 340 basis points (3.4%) on the back of a rise in purchase of finished goods and other expenditure (as percentage of sales)

  • PAT declines by 11% YoY largely led by the 17% YoY fall in operating profits

Financial performance: A snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 1,403 1,388 -1.0%
Expenditure 1,113 1,149 3.2%
Operating profit (EBDITA) 290 240 -17.3%
EBDITA margin (%) 20.7% 17.3%  
Other income 114 121 6.2%
Interest (net) 2 1 -6.7%
Depreciation 7 7 1.5%
Profit before tax 396 353 -10.9%
Tax 138 124 -10.3%
Profit after tax/(loss) 257 228 -11.3%
Net profit margin (%) 18.3% 16.5%  
No. of shares (m) 32.0 32.0  
Diluted earnings per share (Rs)*   26.8  
Price to earnings ratio (x)*   12.9  
(* on a trailing 12-months basis)

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 the 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 1QFY08?
Revenues Lackluster performance: Novartis' revenues during the quarter, fell by 1% YoY, largely due to the 6% YoY decline in revenues of the pharmaceuticals business (69% of total sales). The company attributed this decline to the impact of price control on one of its key brands. The OTC segment was also under pressure with revenues falling by 4.5% YoY as Novartis faced competitive pressure in this segment. Revenues from the generics segment however, grew by 26% YoY during the quarter owing to the company's focus on areas other than the anti-TB range. The animal health business also did well, clocking a 32% YoY growth primarily led by a recovery in the poultry segment.

Segmental performance
(Rs m) 1QFY07 1QFY08 Change
Pharmaceuticals 1,014 958 -5.6%
PBIT margin (%) 23.3% 22.9%  
Generics 112 141 25.5%
PBIT margin (%) 37.8% 24.5%  
OTC 206 197 -4.5%
PBIT margin (%) 23.8% 11.1%  
Animal health 70 93 32.1%
PBIT margin (%) 3.7% 8.1%  
Total revenues 1,403 1,388 -1.0%
Total PBIT margin (%) 23.5% 14.5%  

Fall in operating margins: Novartis' operating margins contracted by 340 basis points (3.4%) during the quarter due to the rise in purchase of finished goods, staff costs and other expenditure (as percentage of sales). The company, however, managed to keep its raw material costs and advertisement expenses under control. While margins are expected to expand going forward backed by an improved product mix in both its pharmaceuticals and OTC businesses, we do not expect the company to attain the margins of its peers GSK Pharma, Aventis and Pfizer (above 25%).

Cost break-up
(% sales) 1QFY07 1QFY08
(Increase)/ decrease in stock 3.2% 0.1%
Raw material consumption 3.9% 4.5%
Staff cost 9.6% 11.3%
Purchase of finished goods 37.0% 39.1%
Advertisement and sales promotion 7.1% 7.1%
Other expenditure 18.5% 20.6%

Bottomline woes: Poor performance at the operating level largely contributed to the 11% YoY decline in the bottomline. However, this fall was relatively slower as compared to the 17% YoY decline in the operating profits on the back of a higher other income and lower depreciation charges.

Quarterly trend
(%) 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Net sales growth 32.4% -12.4% 5.4% 7.6% 18.2% -1.0%
Operating profit margin 11.5% 20.7% 15.5% 16.6% 12.0% 17.3%
Net profit margin 19.1% 18.3% 13.8% 14.2% 19.3% -11.3%

What to expect?
At the current price of Rs 346, the stock is trading at a price to earnings multiple of 10.8 times our estimated FY10 earnings. Going forward, the pharmaceutical and OTC businesses are expected to be the key growth drivers, which will largely be driven by new product launches. With the advent of the product patent law in India, Novartis has unveiled plans to launch patented products in India from 2007 onwards. Having said that, we expect the generics segment to witness pressure going forward owing to the difficult pricing environment in the anti-TB segment. While valuations look attractive, considering the volatility in Novartis' performance over the last five years, our preferred plays are Pfizer and Aventis in the MNC pharma space.

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