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Cipla: Formulations led growth - Views on News from Equitymaster
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Cipla: Formulations led growth
Oct 24, 2007

Performance summary
  • Revenues grow by a robust 25% YoY due to strong performances by the domestic and export formulations businesses.
  • EBDITA margins contract by 510 basis points (5.1%) led by a substantial rise in raw material costs (as percentage of sales).

  • Net profits report a staid 5% YoY growth bolstered by a higher other income (up 120% YoY).

Financial performance: A snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 8,930 10,984 23.0% 17,531 20,002 14.1%
Expenditure 6,654 8,744 31.4% 12,967 16,155 24.6%
Operating profit (EBIDTA) 2,276 2,240 -1.6% 4,565 3,847 -15.7%
Operating profit margin (%) 25.5% 20.4%   26.0% 19.2%  
Other income 190 418 120.2% 409 604 47.4%
Interest 16 24 51.9% 44 32 -26.7%
Depreciation 245 328 33.7% 505 630 24.8%
Profit before tax 2,205 2,307 4.6% 4,426 3,789 -14.4%
Tax 403 401 -0.4% 919 685 -25.4%
Profit after tax/ (loss) 1,803 1,906 5.7% 3,507 3,104 -11.5%
Net profit margin (%) 20.2% 17.4%   20.0% 15.5%  
No. of shares (m) 777.2 777.2   777.2 777.2  
Diluted earnings per share (Rs)*         6.0  
P/E ratio (x)*         32.7  
(* on a trailing 12-months basis)

What is the company’s business?
Cipla is the second largest pharma company in the domestic retail market (ORG survey) and has presence in formulations and bulk drugs manufacturing. All the bulk drug manufacturing facilities of the company have been approved by the US FDA and the formulation facilities have been approved by the Medicine Control Agency (UK), the Medicine Control Council (South Africa), the Therapeutic Goods Administration (Australia) and other international agencies. On the exports front, the company has strategic alliance with major generic manufactures such as Watson, Mylan, Barr and Ivax for supply of bulk drugs. It has a very wide product range in the domestic market, which includes antibiotics, anti-bacterial, anti-asthmatics, anti-inflammatory, antiretroviral, anti-cancer and cardiovascular. The company also concentrates on developing specialty bulk drugs for export markets.

What has driven performance in 2QFY08?
Formulations deliver: Cipla clocked a robust 23% YoY topline growth during 2QFY08, led by strong performances of both its domestic and export formulations businesses. Domestic sales grew by 15% YoY and was driven by the anti-asthmatics, cardiovascular, anti-biotics and anti-retrovirals segments. Export growth of 25% YoY during the quarter was attributed to the healthy 45% YoY growth reported by the formulations segment. Like in the previous two quarters namely 4QFY07 and 1QFY08, API exports continued to disappoint and declined by 11% YoY during 2QFY08. While the sales from the domestic and the exports formulations business is in line with our estimates, we shall have to revise downwards our revenue estimates for the API exports business.

Business snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Domestic 4,444 5,094 14.6% 9,173 10,147 10.6%
Exports            
- Formulations 2,800 4,059 45.0% 5,987 7,262 21.3%
- APIs 1,597 1,417 -11.3% 2,349 2,233 -4.9%
Total exports 4,397 5,476 24.5% 8,335 9,496 13.9%
Total sales 8,841 10,570 19.6% 17,508 19,643 12.2%
Other operating income            
- Technology knowhow/fees 176 413 135.2% 266 527 98.0%
- Others 136 191 40.9% 248 293 18.4%
Total 311 605 94.1% 514 820 59.6%
Total income from operations 9,153 11,175 22.1% 18,022 20,463 13.5%

Operating margin scenario: Operating margins shrunk considerably by 510 basis points (5.1%) due to rise in raw material costs and other expenditure (as percentage of sales) leading to the 2% YoY fall in operating profits. Raw material costs increased due to a change in the product mix. Other expenditure, during the quarter, rose on account of increased expenditure on advertisement, sales and travel expenditure. The operating margins are in line with our estimates.

Cost break-up
(% of sales) 2QFY07 2QFY08 1HFY07 1HFY08
Raw material cost 46.0% 49.9% 45.5% 49.9%
Staff cost 4.9% 4.8% 5.4% 5.9%
Other expenditure 23.6% 24.9% 23.1% 25.0%

Muted bottomline: While the operating profits fell by 2% YoY, higher other income (up 120% YoY) and lower tax expenses were instrumental in propping up the bottomline, which grew by 5% YoY. Tax expenses for the quarter declined due to tax incentives available for its EOUs and its plant at Baddi. Foreign exchange gains (to the tune of Rs 200 m) on account of revaluation of forward contracts, outstanding debtors and foreign currency loans contributed to substantial rise in other income.

Over the quarters: While Cipla’s performance from 3QFY07 onwards has witnessed a slowdown, the revival in revenue growth in 2QFY08 has been an encouraging sign. Having said that, the decline in API exports remains a cause for concern.

Quarterly trend
  1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales growth 30.3% 33.3% 12.4% 6.3% 4.9% 23.0%
Operating profit margin 26.5% 25.4% 24.9% 15.7% 17.8% 20.4%
Net profit growth 53.0% 45.8% 5.2% -34.1% -29.7% 5.7%

What to expect?
At the current price of Rs 196, the stock is trading at a price to earnings multiple of 14.1 times our estimated FY10 earnings. We believe that Cipla’s focus on contract manufacturing shall gather momentum in the future keeping in mind the global generics potential. In the domestic market, the company is likely to maintain its strength with its strong field presence and strong brands. That said, while in the medium term, the poor performance of the API exports is a cause for concern, in the longer term, the company’s minimal focus on R&D is likely to weigh heavy on its overall growth. Given the fact that the performance of the company for the half-year has been lower than our estimates for the full year, especially on the revenue front, we shall have to revise our revenue estimates while keeping the operating margin numbers intact. Overall, we maintain our positive view on the stock.

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