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Nicholas Piramal: ‘Formulations’ disappoint! - Views on News from Equitymaster
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Nicholas Piramal: ‘Formulations’ disappoint!
Oct 21, 2005

Performance Summary
Nicholas Piramal has announced dismal results for the second quarter ending September 2005, which has also reflected in its half-year performance. A decline in domestic formulations business has adversely impacted the topline. This coupled with a rise in expenditure led to a contraction in operating margins, consequently impacting the bottomline, which remained flat despite a substantially higher other income component and lower tax outgo.

Financial performance: A snapshot
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 3,564 3,481 -2.3% 7,029 7,251 3.2%
Expenditure 2,780 2,869 3.2% 5,612 5,926 5.6%
Operating profit (EBDITA) 784 611 -22.1% 1,417 1,325 -6.5%
EBDITA margin (%) 22.0% 17.6%   20.2% 18.3%  
Other income 45 179 297.8% 122 239 95.9%
Interest (net) 44 53 20.6% 67 98 46.0%
Depreciation 114 142 24.7% 220 280 26.9%
Profit before tax 671 595 -11.3% 1,252 1,187 -5.2%
Extraordinary item (23) (1) -96.1% (23) (6) -74.7%
Tax 105 45 -56.6% 197 91 -54.1%
Profit after tax/(loss) 544 549 0.9% 1,031 1,090 5.7%
Net profit margin (%) 15.3% 15.8%   14.7% 15.0%  
No. of shares (m) 190.0 209.0   190.0 209.0  
Diluted earnings per share (Rs)*       9.9 10.4  
Price to earnings ratio (x)         22.7  
(* annualised)            

What is the company’s business?
Nicholas Piramal is one of the leading Indian pharma companies with strong focus in the domestic market. It is the fourth largest pharma company with 4.3% share (FY05) of the domestic market and a large sales force covering 10 therapeutic segments. The company has started focusing on the exports market too and the contribution of exports in total sales has increased to 12% from zero in the space of three years. It has gradually improved its product portfolio by increasing the share of lifestyle drugs and has also started focusing on R&D off late. The biggest contributor to company’s revenue is the respiratory and cardiovascular segment. The other major therapeutic segments in which the company operates are anti-infectives, nutritional and gastro intestinal.

What has driven performance in 2QFY06?
Formulations formulate topline decline: Nicholas Piramal’s topline declined by 2% YoY during the quarter chiefly on account of a 7.5% drop in its domestic formulations (77% of total revenues). The decline in revenues was attributed to the following three factors:
  1. ‘Phensedyl’, which is a leading brand of the company, was embroiled in a controversy, which saw the Narcotics Control Bureau (NCB) initiate investigation into the sale of the product. This was because the NCB claimed that ‘Phensedyl’ contained a high amount of codeine leading to the product being classified as a narcotic. This adversely affected sales of ‘Phensedyl’. The company has however been successful in establishing that ‘Phensedyl’ is not a narcotic drug.

  2. The company also had to withdraw the drug ‘Valdecoxib’. This is in line with the trends in the global as well as the Indian pharmaceutical market, wherein most of the pharma companies selling this drug have withdrawn it from the market following the Merck (read ‘Vioxx’) debacle.

  3. A spin-off of the company’s Rs 160 m Carex division.

If one were to look delve further into the domestic formulations business, the respiratory segment, due to the ‘Phensedyl’ fiasco, witnessed a 35% YoY decline as compared to the market growth rate of 2% YoY. The dermatology segment too fell by 10% YoY as against the industry growth of 10%. This was due to the fact that the prices of the company’s product ‘Lobet’ were reduced by the NPPA. In all the remaining segments, the company managed to clock growth in revenues. Exports clocked a robust 20% YoY growth on the back of the inhalations business, which the company had acquired from Rhodia.

Margins contract: Operating margins reduced by 440 basis points owing to a rise in expenditure (as a percentage of sales) on almost all the fronts and a subdued topline. The considerable increase in R&D expenditure was attributed to the fact that the company’s oncology molecule is currently undergoing Phase I clinical trials in Canada.

Cost break-up
(% of sales) 2QFY05 2QFY06 1HFY05 1HFY06
Raw material 41.5% 45.7% 43.5% 46.6%
Staff cost 11.2% 11.7% 11.2% 10.8%
Marketing & selling expenses 13.1% 12.1% 13.3% 12.7%
R&D expenses 2.8% 4.2% 2.6% 3.8%
Other expenditure 8.4% 8.6% 8.5% 7.7%

Other income cushion: The effect of a dip in revenues coupled with contraction in operating margins percolated down to the bottomline, which remained flat. However, it must be noted that the bottomline picture would have been worse had it not been for the sharp spurt in the other income. Other income included dividend income, which the company received from Allergan India Private Ltd.

Over the last few quarters: Nicholas’ revenue growth has been rather inconsistent, which could be attributed to the snapping of ties with Roche Diagnostics (an international pharma company), VAT related concerns in 4QFY05 and the ‘Phensedyl’ controversy in 2QFY06. However, with the exception of 4QFY05, the company has managed to consistently maintain operating margins above 15%.

Quarterly trend
(%) 1QFY05 2QFY05 3QFY05 4QFY05* 1QFY06 2QFY06
Net sales growth 15.9% 2.0% 9.0% -31.0% 8.8% -2.3%
Operating profit margin 18.1% 21.9% 16.6% -9.2% 18.9% 17.6%
Net profit growth 41.3% 7.0% 99.4% - 12.2% 0.9%
*Net loss in 4QFY05

What to expect?
At the current price of Rs 237, the stock is trading at a price to earnings multiple of 23.0 times our estimated FY08 earnings, which is at the higher end of the valuation spectrum. We believe that contract manufacturing, though in its initial stages, is likely to be a key growth driver for the company going forward. In this regard, the company has secured two agreements (one with a Fortune 500 company and the other with Allergan Inc., US). The company also expects to sign five new, long-term custom manufacturing contracts by the end of November 2005. However, it will take around two years for these contracts to start generating revenues. Post the product patent regime, the company has initiated steps on the R&D front with its oncology molecule commencing Phase I clinical trials in Canada. However, we believe that the company is unlikely to introduce any patented products of its own over the next 3-4 years.

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