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Pfizer: Prescription for growth? - Views on News from Equitymaster

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Pfizer: Prescription for growth?

Sep 27, 2005

Performance Summary
MNC pharma major, Pfizer India, announced its results for the third quarter and nine months ending August 2005 (November ending) late yesterday. The topline has witnessed a healthy growth in the third quarter after the VAT fiasco in the previous 2 quarters. This coupled with efficiencies at the operating level has led to a sharp margin expansion and consequently a robust bottomline growth.

Financial performance: A snapshot
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 1,415 1,627 15.0% 4,133 4,306 4.2%
Expenditure 1,236 1,267 2.5% 3,655 3,467 -5.2%
Operating profit (EBIDTA) 179 361 101.2% 477 839 75.8%
Operating profit margin (%) 12.7% 22.2%   11.6% 19.5%  
Other income 86 102 18.3% 268 291 8.7%
Interest (net) 2 -   5 2 -72.2%
Depreciation 25 32 30.6% 72 99 37.7%
Profit before tax 238 430 80.4% 668 1,030 54.2%
Exceptional items (expense) (32) (83) 160.9% (153) (200) 30.1%
Tax 72 129 79.1% 200 323 61.6%
Profit after tax 134 218 62.2% 315 508 61.3%
Net profit margin (%) 9.5% 13.4%   7.6% 11.8%  
No. of shares (m) 28.8 29.8   28.8 29.8  
Diluted earnings per share (Rs)       14.1 22.7  
P/E ratio (x)*         36.0  

What is the company’s business?
Pfizer India is a 40% subsidiary of the world's largest pharmaceuticals company, Pfizer Inc. It has some strong brands in its portfolio like Corex (cough syrup) and Becosules (B-complex supplement), which contribute over 30% to company's revenues. The company has merged Parke Davis and Pharmacia with itself. Pfizer derives most of its revenues from the pharmaceuticals division (86%). The company also has presence in the animal health (10%) and clinical development operations (4%) segments. In the animal health segment, Pfizer plans to capitalize on its parent's global leader status and become a major player. Pfizer also carries out clinical trials on behalf of its parent.

What has driven performance in 3QFY06?
Revenue recovery: Pfizer was badly affected in the previous two quarters on account of the VAT debacle, which led to a 1% decline in revenues during the same period. However, the company staged a healthy recovery in 3QFY06 posting a 15% YoY growth. This can chiefly be attributed to its pharmaceutical business (around 86% of revenues), which clocked a robust 16% YoY growth during the quarter. However, for 9mFY06, revenues registered a tepid 4% YoY growth owing to the dismal first two quarters of the year.

As far as its other business segments are concerned, the animal healthcare business (10% of revenues) was the laggard this time with a 1% YoY decline in revenues. The clinical operations business, despite contributing a relatively marginal 4% to revenues, performed well by clocking an impressive 57% YoY growth.

Segmental performance
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Pharmaceuticals (incl. services) 1,285 1,489 15.9% 3,754 3,883 3.5%
PBIT margin (%) 23.9% 30.9%   22.6% 28.1%  
Animal health (incl. services) 147 146 -0.5% 427 439 2.8%
PBIT margin (%) 13.6% 27.8%   7.7% 8.6%  
Services - Clinical            
Development Operations 39 61 57.0% 109 176 62.3%
PBIT margin (%) 10.1% 11.7%   9.9% 10.7%  
Total revenues 1,470 1,696 15.3% 4,290 4,499 4.9%
Total PBIT margin (%) 22.5% 29.9%   20.8% 25.5%  

Margin improvement continues: Tight control over operating costs coupled with a better product mix led to higher operating margins during both 3QFY06 and 9mFY06. Sharp decline in the raw material costs and other expenditure (both as percentage of revenues) has aided the margin expansion. More importantly, in this quarter, revenue growth has also been largely responsible for the improvement in margins.

Cost break-up
(% of sales) 3QFY05 3QFY06 9mFY05 9mFY06
Material consumption 23.2% 20.1% 26.5% 20.9%
Purchase of finished goods 12.3% 12.4% 14.4% 14.1%
Staff cost 15.4% 15.6% 15.5% 16.5%
Other expenditure 36.4% 29.8% 32.0% 29.0%

Bottomline shines: It must be noted that Pfizer’s inventories at its Bhiwandi warehouse were badly damaged on account of the incessant rains on July 26, 2005 and the floods thereafter. The estimated loss on account of the same was pegged at Rs 24 m (net of estimated insurance claim). This resulted in a rise in its extraordinary expense. Despite this setback, Pfizer’s continued focus on efficiencies at the operating level and healthy revenue growth was reflected in the bottomline, which was up 62% YoY during the quarter. However, if one excludes the effect of the extraordinary item, bottomline during the quarter grew by a higher 81% YoY.

Over the quarters: Despite the volatility in Pfizer’s sales over the quarters, there seems to be a recovery on this front. Also, operating margins have been on an upward trend (though not on par with its peers Glaxo and Aventis), which is commendable.

What to expect?
At the current price of Rs 817, the stock is trading at a price to earnings multiple of 25.2 times our estimated FY08 earnings, which is at the higher end of our valuation spectrum. The management has indicated that it expects the operating margins to improve above 20% (average 17% in the last four years) going forward (as has been the case this quarter), in line with its peers in the industry such as Glaxo (28%) and Aventis (29%). The margin improvement is expected to come from an increase in turnover, price increases in products (wherever it is possible) and continued efficiency at the operating level.

Also, in the past, the company was not keen on introducing new products due to India’s patent laws, which recognised process patents and not product patents. However, post 2005, the scenario has changed with India accepting the WTO norms. The management has already indicated that it will look at launching 2 products a year and is planning to launch its patented products from 2007 onwards. We believe that the company is set to aggressively explore this market opportunity, which is likely to contribute to a higher growth in the future.

Having said that, on account of the slower revenue growth in 9mFY06, we will be downgrading our numbers accordingly.

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