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Novartis: Businesses deliver - Views on News from Equitymaster
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Novartis: Businesses deliver
Oct 24, 2007

Performance summary
  • Revenues record a decent 14% YoY for 2QFY08 growth led by the pharmaceuticals, generics and animal health businesses.

  • EBDITA margins expand sharply by 730 basis points (7.3%) largely led by inventory related adjustments.

  • Net profits grow by a splendid 70% YoY aided by the strong performance at the operating level and lower depreciation charges.

Financial performance: A snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 1,294 1,479 14.3% 2,697 2,867 6.3%
Expenditure 1,093 1,142 4.5% 2,206 2,291 3.9%
Operating profit (EBDITA) 201 337 67.4% 491 576 17.4%
EBDITA margin (%) 15.5% 22.8%   18.2% 20.1%  
Other income 85 101 19.5% 199 222 11.9%
Interest (net) 1 1 7.7% 3 3 0.0%
Depreciation 7 7 2.9% 14 14 2.2%
Profit before tax 278 429 54.6% 673 782 16.1%
Tax 103 185 80.0% 241 309 28.2%
Extraordinary item 4 60   4 60  
Profit after tax/(loss) 179 304 70.1% 436 532 22.1%
Net profit margin (%) 13.8% 20.6%   16.2% 18.6%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)*         30.7  
Price to earnings ratio (x)*         9.9  
(* on a trailing 12-months basis)

What is the company’s business?
Novartis is a leading player in certain therapeutic segments with strong brands like ‘Voveron’, ‘Tegrital’ and ‘Calcium Sandoz’. The company has a strong presence in the anti-TB, respiratory and anti-inflammation segments. Also, it has a very strong parent backup, which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has no manufacturing operations in India and all the products that Novartis sells are either outsourced from a local producer or imported from the parent company. Thus, this company should be seen as a trading company rather than a drug manufacturing company.

What has driven performance in 2QFY08?
Revenues – Decent performance: Novartis reported a strong 14% YoY growth in revenues led by decent performances of the pharmaceuticals, generics and animal health businesses. The sales from the OTC segment, however, declined by 3% YoY due to competitive pressure. The strong 18% growth in the generics segment could be attributed to the company’s focus on areas other than the anti-TB range. The 18% YoY growth in the pharmaceuticals segment, which accounts for 70% of total sales, was also instrumental in bolstering the overall topline performance.

Segmental performance
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Pharmaceuticals 886 1,042 17.5% 1,900 1,999 5.2%
PBIT margin (%) 19.7% 33.9%   21.6% 28.6%  
Generics 109 128 17.7% 221 269 21.7%
PBIT margin (%) 27.4% 24.2%   32.7% 24.3%  
OTC 194 189 -2.6% 401 386 -3.6%
PBIT margin (%) 11.2% 17.7%   17.7% 14.3%  
Animal health 104 119 14.7% 174 212 21.7%
PBIT margin (%) 11.0% 15.3%   8.0% 12.2%  
Total revenues 1,294 1,479 14.3% 2,697 2,867 6.3%
Total PBIT margin (%) 18.4% 29.5%   21.1% 25.1%  

Improvement in operating margins: Novartis’ operating margins expanded by an impressive 730 basis points (7.3%) during the quarter, which has largely been due to stock-related adjustments. Besides this, the company managed to keep its advertisement and other expenses under control. Given the fact that Novartis sources its products from third-party manufacturers, purchase of finished goods (as percentage of sales) witnessed a rise. Going forward, we expect margins to improve backed by an improved product mix in both its pharmaceuticals and OTC businesses, which was amply demonstrated in this quarter as well (while the PBIT margins of pharmaceuticals improved from 20% in 2QFY07 to 34% in 2QFY08, that of the OTC business improved from 11% in 2QFY07 to 18% in 2QFY08).

Cost break-up
(% sales) 2QFY07 2QFY08 1HFY07 1HFY08
(Increase)/ decrease in stock 5.6% -1.5% 4.3% -0.7%
Raw material consumption 3.8% 4.2% 3.9% 4.4%
Purchase of finished goods 36.5% 39.0% 36.8% 39.0%
Staff cost 9.8% 9.0% 9.7% 10.1%
Advertisement and sales promotion 8.7% 7.0% 7.9% 7.1%
Other expenditure 20.1% 19.6% 19.3% 20.1%

Bottomline surges: A splendid performance at the operating level trickled down to the bottomline, which clocked an impressive 70% YoY growth. A higher other income and lower depreciation charges also had a favourable impact on the growth in the bottomline.

Quarterly trend
(%) 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales growth -12.4% 5.4% 7.6% 18.2% -1.0% 14.3%
Operating profit margin 20.7% 15.5% 16.6% 12.0% 17.3% 22.8%
Net profit margin 18.3% 13.8% 14.2% 19.3% -11.3% 20.6%

What to expect?
At the current price of Rs 314, the stock is trading at a price to earnings multiple of 9.1 times our estimated FY10 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. Besides this, the management’s plans of launching patented products in India from 2008 onwards can be construed as a positive step. Thus, we maintain our positive view on the stock.

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