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Novartis: Bogged by lower margins
Oct 20, 2008

Performance summary
  • Revenues grow by a staid 3% YoY for 2QFY09 attributed to the poor performance of its pharma division.

  • EBDITA margins contract by 2.7% largely due to a rise in staff costs and other expenditure (as percentage of sales).

  • Decline in operating profits lead to a fall in net profits, the magnitude of the latter being lower due to higher other income.



Financial performance: A snapshot
(Rs m) 2QFY08 2QFY09 Change 1HFY08 1HFY09 Change
Net sales 1,556 1,600 2.8% 2,966 3,157 6.4%
Expenditure 1,142 1,217 6.6% 2,291 2,413 5.3%
Operating profit (EBDITA) 414 383 -7.5% 675 744 10.2%
EBDITA margin (%) 26.6% 23.9%   22.8% 23.6%  
Other income 83 130 56.4% 183 245 33.7%
Interest (net) 1 1 -42.9% 3 2 -46.4%
Depreciation 7 7 -8.5% 14 14 -2.2%
Profit before tax 489 506 3.5% 842 974 15.7%
Tax 185 214 15.8% 309 385 24.6%
Profit after tax/(loss) 304 292 -3.9% 532 589 10.6%
Net profit margin (%) 19.5% 18.2%   17.9% 18.6%  
No. of shares (m)       32.0 32.0  
Diluted earnings per share (Rs)         32.1  
Price to earnings ratio (x)*         7.6  
*based on trailing 12 months earnings

What has driven performance in 2QFY09?
  • 2QFY09 proved to be a dull quarter for Novartis after the strong show it had put up in 1QFY09. Revenues grew by a staid 3% YoY and were largely due to the 1% YoY growth in sales from the pharma division, which accounts for 68% of total sales. While the animal health business grew by a robust 14% driven by focus on institutional sales, the generics division grew by 13% YoY and can be attributed to tender sales recorded during the quarter. The OTC business, which saw its sales slump by 6% YoY in 1QFY09, made a strong recovery during 2QFY09 with revenues growing by 12% YoY, thereby propping up sales during the half year period.

    Segmental performance
    (Rs m) 2QFY08 2QFY09 Change 1HFY08 1HFY09 Change
    Pharmaceuticals 1,042 1,053 1.1% 1,999 2,105 5.3%
    PBIT margin (%) 33.9% 32.3%   28.6% 31.4%  
    Generics 128 144 12.5% 269 331 23.2%
    PBIT margin (%) 24.2% 20.8%   24.3% 20.5%  
    OTC 189 211 11.7% 386 397 2.7%
    PBIT margin (%) 17.7% 12.4%   14.3% 10.0%  
    Animal health 119 136 14.2% 212 249 17.1%
    PBIT margin (%) 15.3% 14.5%   12.2% 15.0%  
    Total revenues 1,479 1,545 4.5% 2,867 3,082 7.5%
    Total PBIT margin (%) 29.5% 26.9%   25.1% 26.2%  

  • Novartis' operating margins contracted by 2.7% during the quarter, which was largely due to a rise in staff costs and other expenditure (as percentage of sales). For 1HFY09 however, operating margins improved marginally by 0.8%. Going forward, we expect margins to improve backed by an improved product mix in its pharmaceuticals, OTC and animal health businesses. To put things into perspective, the PBIT margins of the pharmaceutical segment improved from 28.6% in 1HFY08 to 31.4% in 1HFY09, while that of the animal health business expanded from 12.2% in 1HFY08 to 15% in 1HFY09.

  • Decline in operating profits (down 8% YoY) led to the 4% YoY fall in net profits. However, this fall was relatively lower due to higher other income. During the half year period net profits managed to grow in tandem with the growth in operating profits.

What to expect?
    At the current price of Rs 243, the stock is trading at a price to earnings multiple of 5.1 times our estimated FY11 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. In the pharma business, the company has chalked a strategy of driving growth through life cycle management of existing products and in-licensing opportunities. In the OTC segment, consolidation of existing brands and launch of new products in various categories is expected to augur well for this business. Thus, we maintain our positive view on the stock from a long-term perspective.

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