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Cipla: ‘Formulations’ formulate growth! - Views on News from Equitymaster
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Cipla: ‘Formulations’ formulate growth!
Oct 27, 2005

Performance summary
Cipla has announced strong results for the second quarter and half year ended September 2005. While the strong growth in formulations exports has boosted the topline for the quarter, improved product mix and cost efficiency has led to a substantial improvement in operating margins. This has trickled down to the bottomline, which has posted a healthy 28% YoY growth, despite a significant fall in other income and an increase in depreciation charges.

Financial performance: A snapshot
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 5,814 6,717 15.5% 11,108 13,345 20.1%
Expenditure 4,495 4,944 10.0% 8,722 10,073 15.5%
Operating profit (EBIDTA) 1,319 1,773 34.4% 2,386 3,272 37.1%
Operating profit margin (%) 22.7% 26.4%   21.5% 24.5%  
Other income 74 15 -79.4% 193 99 -48.8%
Interest 40 17 -57.2% 53 31 -42.5%
Depreciation 125 215 72.0% 255 350 37.3%
Profit before tax 1,229 1,556 26.6% 2,271 2,990 31.7%
Tax 270 330 22.2% 520 650 25.0%
Profit after tax/ (loss) 959 1,226 27.9% 1,751 2,340 33.6%
Net profit margin (%) 16.5% 18.3%   15.8% 17.5%  
No. of shares (m) 299.9 299.9   299.9 299.9  
Diluted earnings per share (Rs)*       11.7 15.6  
P/E ratio (x)         22.9  
(* annualised)            

What is the company’s business?
Cipla is the third largest pharma company in the retail market according to the latest ORG survey. The company 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 2QFY06?
Exports outpace domestic sales: During the quarter, domestic sales of the company were affected on account of heavy rains in the state of Maharashtra causing considerable damage to inventory stored at Bhiwandi (one of its warehouses is located here). However, despite this setback, the company managed to post a healthy 16% YoY growth in topline. While domestic sales remained largely flat and the Active Pharmaceutical Ingredient (API) exports actually witnessed a 13% YoY decline, it was the formulation exports, which provided the saving grace for the topline. Formulation exports clocked an impressive 57% YoY during the quarter. Total exports in 2QFY06 contributed 47% to the company’s revenues.

Business snapshot
  2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Domestic 3,633 3,636 0.1% 7,164 7,576 5.8%
Exports            
Formulations 1,579 2,480 57.0% 2,997 4,634 54.6%
APIs 838 725 -13.4% 1,452 1,419 -2.2%
Total exports 2,417 3,206 32.6% 4,448 6,053 36.1%
Total sales 6,050 6,841 13.1% 11,612 13,628 17.4%
Other operating income            
Technology knowhow/fees 97 75 -22.6% 170 94 -44.9%
Others 64 51 -20.4% 112 255 127.8%
Total 162 127 -21.7% 282 348 23.5%
Total income from operations 6,212 6,968 12.2% 11,894 13,977 17.5%

Improvement in operating margins: Cipla expanded its operating margins in the quarter by a considerable 370 basis points owing to the fall in raw material costs as a percentage of sales. Improved product mix has also led to the margin expansion. During the quarter, the increase in other expenses was mainly due to a rise in manufacturing overheads including power & fuel and stores & spares. This incremental expenditure was owing to an increase in the level of operations as well as the Baddi factory becoming operational in 1HFY06.

Cost break-up
  2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Raw material 2,938 2,911 -0.9% 5,644 6,061 7.4%
(as % of sales) 50.5% 43.3%   50.8% 45.4%  
Staff cost 262 303 15.8% 564 696 23.4%
(as % of sales) 4.5% 4.5%   5.1% 5.2%  
Other expenditure 1,295 1,730 33.6% 2,514 3,317 31.9%
(as % of sales) 22.3% 25.8%   22.6% 24.9%  
Total 4,495 4,944   8,722 10,073  

Strong bottomline: Strong revenues and improved operating margins provided a kicker to the bottomline, which grew 28% YoY. This growth was, however, at a relatively slower pace as compared to operating profits, which grew at a faster clip of 34% YoY. This was on account of a significant 72% YoY rise in depreciation charges and a 79% YoY fall in other income. Depreciation charges witnessed a steep rise owing to substantial additions made to fixed assets at Goa and Baddi.

Over the quarters: Despite the decline in revenues in 4QFY05 owing to VAT related concerns, Cipla’s performance at the topline level has been very encouraging due to a strong growth in the domestic market as well as exports. At the operating level also, the company has consistently managed to maintain margins above 20% levels, which is commendable.

Quarterly trend
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06 2QFY06
Net sales growth 25.1% 28.8% 24.0% -6.1% 24.2% 15.5%
Operating profit margin 18.8% 22.7% 20.2% 25.6% 22.6% 26.4%
Net profit growth 17.9% 37.9% 66.8% 3.8% 40.5% 27.9%

What to expect?
At the current price of Rs 358, the stock is trading at a price to earnings multiple of 16.2 times our estimated FY08 earnings. Cipla is significantly increasing its international operations and we believe that, on the exports front, the company will be a strong performer due to its long standing in the industry and technological skills. Also, being one of the most efficient producers of bulk drugs, Cipla is likely to maintain margins in the international markets, where it has adopted a low risk strategy of supplying bulk drugs to generic companies like Ivax and Watson. In the domestic market, the company is likely to maintain its strength with its strong field presence and strong brands.

We had recommended a ‘Buy’ on the stock in May 2005 at Rs 272 with a target price of Rs 442 from a long-term perspective. Considering the current growth momentum and bright future prospects of the company, we maintain our view on the stock.

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