Abbott India: Consistency, an issue? - Views on News from Equitymaster

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Abbott India: Consistency, an issue?

Sep 28, 2005

Performance summary
MNC pharma company, Abbott India, announced mixed results for the third quarter and nine months ending August 2005 (November year ending). While the topline registered a robust growth, inefficiencies at the operating level resulted in a drop in operating margins. This coupled with a drastic reduction in other income has hit the bottomline hard.

Financial performance: A snapshot
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 1,046 1,237 18.2% 2,997 3,272 9.2%
Expenditure 816 1,014 24.2% 2,347 2,697 14.9%
Operating profit (EBIDTA) 230 223 -3.0% 651 575 -11.6%
Operating profit margin (%) 22.0% 18.0%   21.7% 17.6%  
Other income 314 25 -91.9% 495 89 -82.1%
Interest (net) - - - 1 -  
Depreciation 10 10 -1.0% 30 29 -2.7%
Profit before tax 534 238 -55.3% 1,115 635 -43.0%
Tax 101 78 -23.0% 257 197 -23.5%
Profit after tax 433 161 -62.8% 858 439 -48.9%
Net profit margin (%) 41.4% 13.0%   28.6% 13.4%  
No. of shares (m) 15.3 15.3   15.3 15.3  
Diluted earnings per share (Rs)*       74.8 38.2  
P/E ratio (x)         16.7  
(* annualised)            

What is the company’s business?
Abbott India is a 38% subsidiary of Abbott Laboratories Inc., US. Abbot Laboratories (a global healthcare company with focus on pharmaceuticals, nutritional and medical products including devices and diagnostics) is the world's 11th largest pharma company. Abbott India focuses on core therapeutic areas in pharmaceuticals, namely urology, gastroenterology, pain management, benign prostatic hyperplasia and specialized anesthesia range, with well-known brands like Brufen, Digene, Cremaffin, Hytrin and Norvir. In India, Abbott is principally a trading company and most of its products are either imported from its parent or outsourced to other manufacturers in India.

What has driven performance in 3QFY06?
Strong revenue growth: Revenues in 3QFY06 grew at a healthy pace, clocking an 18% YoY growth. This can be attributed to the continued recovery in sales after the VAT fiasco in the first quarter and the company’s focus on the lifestyle segment, including its core therapeutic areas, which are CNS products, diabetes and urology. For 9mFY06, the company recorded a relatively slower 9% YoY growth in revenues (VAT uncertainties had adversely impacted revenues in 1QFY06, down over 3% YoY). With lifestyle diseases on the rise, the company is expected to capitalize on this opportunity going forward.

Margins under pressure: Abbott has faced severe pressure on the operational front with a 400 basis points decline in margins as compared to its peers Glaxo and Pfizer, which have shown considerable margin expansion owing to better efficiencies. The company has attributed the decline in operating margins in 3QFY06 and 9mFY06 to the levy of excise duty on the basis of MRP. There has been a considerable increase in the purchase of finished goods (as a percentage of sales), which has put further pressure on margins. The increase in purchase of goods and a significant fall in raw material consumption suggest that company has increased the outsourcing of its products to other manufacturers.

Cost break-up
(% sales) 3QFY05 3QFY06 9mFY05 9mFY06
(Increase)/decrease in stock 0.6% -3.5% -0.3% -3.6%
Consumption of raw materials 4.4% 1.7% 4.4% 2.0%
Purchase of finished goods 55.4% 68.3% 57.0% 67.4%
Staff cost 6.3% 5.0% 6.4% 5.8%
Other expenditure 11.3% 10.5% 10.7% 10.9%

Bottomline woes: Reduced operating margins coupled with a sharp decline in other income (down 92% YoY) trickled into the bottomline which dipped 63% YoY during the quarter. This fall in other income is owing to the fact that the company received income from sale of mutual funds units to the tune of Rs 18.4 m in 3QFY06 as against Rs 306 m in the corresponding previous period. If we remove the effect of the sale of mutual fund units, the bottomline has actually registered a 12% YoY growth.

Over the last few quarters: There has been inconsistency in Abbott's performance over the last few quarters. Revenue growth has witnessed a seesaw performance highlighting lack of direction. However, in the last couple of quarters, revenues have been on an upward trend, which is a positive sign. Operating margins, however, have remained largely lacklustre, witnessing virtually no improvement.

What to expect?
At the current price of Rs 640, the stock is trading at a price to earnings multiple of 16.7 times its annualised 9mFY06 earnings, which is at the higher end of our valuation spectrum. Higher share of traded goods in the topline gives an indication of the company’s weak presence in the Indian markets. However, this type of business model can be highly effective, now that the new product patent regime has become applicable in India. The company can now aggressively launch new products in the Indian markets. It is this potential that has seemingly helped the stock to command high valuations. However, we believe that there are better plays in the pharma universe.

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