Novartis consolidates post spin off - Views on News from Equitymaster

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Novartis consolidates post spin off

Aug 23, 2000

An over 40% rise in the stock price (over two months) is the market’s way of looking at the spin off of the agrochemical division by Novartis India. (The international parent Novartis AG has proposed the separation of its agrochemical arm and its merger with the agrochemical arm of Astra Zeneca to form a new company Syngenta. In India too the same process is underway.)

The reasons for this are not far to seek. The healthcare business (this includes the vision care division and the animal health division) is not an asset heavy business since Novartis India outsources most of its production. The top 8 brands of the company contribute almost 49% of its formulation sales (see table).

Product profile
Major ProductsTherapeutic area% of pharma sales
(approx.)
VoveranAnti–inflammatory & pain18.0%
TegretolCentral Nervous System (anti–epileptic)7.0%
RimactazidAnti–TB4.0%
PZA–CIBAAnti–TB4.0%
MethergineGenito–Urinary System6.0%
RegestroneGynaecological3.0%
OtrivinNasal Decongestant4.0%
MacalvitCalcium Supplement3.0%

The overall operating margins of the company, which were around 17% can be expected to increase to around 20% post the hive off of the agrochemical division. Also, the company would be able to reduce its working capital requirements since the inventory days and debtors days can almost be halved from the present levels of 70 days and 55 days respectively.

Consequently, the return on capital would zoom to a mind boggling 64% and the return on equity would improve to 42% in FY2001. Besides, the company has launched five new products over the last two years (see table) all of which are out of the purview of the Drug Price Control Order. This can be expected to improve the margins further.

 FY2000
Pre-spinoff
FY2001
Post-spinoff
ROCE47.0%64.0%
RONW32.0%42.0%
Sales/Assets (times)8.817.8
ROCE is profit before interest and tax divided by the debt plus equity at the end of the year

The improvement in profits, the removal of a seasonal business, the introduction of new products coupled with the almost zero debt status of the company should spell good times for the company. The stock quotes at Rs 879 (52 week range: 1436/618) an earning multiple of 40 times its FY01 earnings. These can be estimated to jump almost 50% over the next two years.

New Products introduced over the last two years
New ProductsPurpose
Femarafor treatment of advanced breast cancer
Exelonfor management of Alzheimer's disease
Epitrilfor treatment of epilepsy and panic disorders
PZA–1000for treatment of TB
3FDfor treatment of TB

Another trigger for the stock could be a sizeable sum from the grant of development rights at its real estate in Goregaon (a suburb of Mumbai). Last year, the company granted development rights on this real estate and this fetched the company an amount of Rs 66 m. (Novartis’ real estate can fetch it around $ 1.5 bn if it were to give development rights for its entire estate.)

The only possible dampener to the stock valuations could be the presence of two 100% subsidiaries of the parent, which would be used to launch nutritional products in the future.

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