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Wockhardt: The ‘India’ effect - Views on News from Equitymaster

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Wockhardt: The ‘India’ effect
Oct 27, 2006

Performance summary
Wockhardt has announced decent results for the third quarter and nine months ended September 2006. Topline has grown at a healthy double-digit pace during the quarter, largely driven by its revenues from the domestic and US businesses. Rise in staff costs and other expenditure have, however, taken their toll on operating margins. Bottomline growth has outpaced operating profit growth backed by higher sales and other income.

Financial performance: A snapshot
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9mCY06 Change
Net sales 3,595 4,377 21.8% 10,462 12,013 14.8%
Expenditure 2,719 3,406 25.3% 8,026 9,230 15.0%
Operating profit (EBDITA) 876 971 10.8% 2,436 2,783 14.2%
Operating profit margin (%) 24.4% 22.2%   23.3% 23.2%  
Other income 29 66 127.6% 153 201 31.4%
Interest 41 -   146 -  
Depreciation 118 141 19.5% 328 409 24.7%
Profit before tax 746 896 20.1% 2,115 2,575 21.7%
Extraordinary item - -   - (604)  
Tax 95 156 64.2% 273 429 57.1%
Profit after tax /(loss) 651 740 13.7% 1,842 1,542 -16.3%
Net profit margin (%) 18.1% 16.9%   17.6% 12.8%  
No. of shares (m) 109.2 109.4   109.2 109.4  
Diluted earnings per share (Rs m)         18.9  
P/E ratio (x)*         21.1  
* on a trailing 12-month basis

What is the company’s business?
Wockhardt Ltd, a subsidiary of Khorakiwala Holdings and Investments Pvt. Ltd (75% stake), is one of the leading domestic pharmaceutical companies with strong presence in the lifestyle segment and a growing focus on biotechnology. With acquisitions in the international markets, the company has demonstrated its growing global ambitions. During 9mCY06, Wockhardt derived 58% of its revenues from non-India regions (63% in CY05). Wockhardt has a subsidiary in the UK, which holds 100% in CP Pharma and Wallis Laboratories. The company has acquired ‘Esparma GmbH’ in Germany and has set up presence in Brazil and the US. The company spent about 4% of consolidated revenues on R&D in 9mCY06 and has proven its R&D capabilities by indigenously developing and launching Biovac-B (Hepatitis-B vaccine), Wepox (Erythropotein) and Wosulin (human insulin).

What has driven performance in 3QCY06?
India is the key driver: Wockhardt’s domestic business registered a robust 39% YoY and a 30% YoY growth in 3QCY06 and 9mCY06 respectively. This growth was largely driven by the company’s focus on high-end niche therapeutic areas, its power brands and new product launches. Wockhardt’s key product portfolios i.e. diabetology and nephrology reported strong growth rates of 27% YoY and 43% YoY respectively. This was aided by its biotech focus with ‘Wepox’ registering a 27% YoY growth and ‘Wosulin’ increasing its share in the devices market from 3% (as per Aug MAT ’05) to 7% (as per Aug MAT ’06). It must be noted that during the quarter, Wockhardt acquired Dumex India, with its two flagship brands ‘Protinex’ and ‘Farex’ in a bid to augment its nutrition portfolio. Dumex recorded revenues of Rs 150 m during the quarter (up 10% QoQ) and contributed 3% to Wockhardt’s 3QCY06 revenues.

Geographical mix
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9mCY06 Change
India 1,446 2,002 38.5% 3,908 5,093 30.3%
US 454 543 19.6% 1,226 1,352 10.3%
Europe 1,358 1,491 9.8% 4,154 4,440 6.9%
Rest of the world (ROW) 337 340 0.9% 1,174 1,128 -3.9%
Total 3,595 4,376 21.7% 10,462 12,013 14.8%

US – Picking up the pieces: Revenues from the US business grew by a healthy 20% YoY during the quarter after a slew of poor performances in the previous two quarters. This was attributed to an increase in ANDA approvals with the company receiving 6 approvals as on September 2006. The company currently has 14 products in the US market with 20 plus ANDAs pending approval out of which around 40% are in the injectables space.

Business mix
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9mCY06 Change
Formulations 3,123 3,925 25.7% 9,155 10,743 17.3%
Bulk 472 451 -4.4% 1,307 1,269 -2.9%
Total 3,595 4,376 21.7% 10,462 12,012 14.8%

Europe – UK tops Germany: Europe clocked a decent 10% YoY revenue growth primarily led by the UK region. Driving sales in this region were new product launches, which included 3 products (out of which 2 were in the hospital segment). Wockhardt’s performance in the UK region is commendable, given the fact that its peers in this region have witnessed a decline in revenues on account of severe pricing pressures. Wockhardt’s better performance can be attributed to the fact that it largely caters to the hospital segment, which is a relatively niche area. The German business, however, reported a decline in revenues due to regulatory changes introduced by the German government.

The company also acquired Ireland based Pinewood Laboratories during the quarter, which is expected to strengthen Wockhardt’s presence in UK, Ireland and Germany going forward. The company has over 200 marketing authorizations in various countries and is liquids and creams business is expected to complement Wockhardt’s strengths in injectable and solid dosages.

Margin pressure evident: Operating margins contracted by 220 basis points during the quarter largely due to a rise in staff costs and other expenditure. Increase in the size of the field force to boost its domestic business has led to the rise in staff costs. Dumex India, being a low margin business, has also impacted operating margins.

Cost break-up
  3QCY05 3QCY06 9mCY05 9mCY06
Raw material consumption 25.8% 20.3% 26.8% 21.5%
Purchase of finished goods 15.7% 19.4% 15.6% 16.4%
Staff cost 12.4% 13.6% 12.7% 14.2%
R&D expenditure 5.6% 3.9% 5.0% 4.0%
Other expenditure 16.1% 20.7% 16.7% 20.6%

Bottomline scenario: Bottomline grew by 14% YoY during the quarter, aided by higher sales and rise in other income. No interest costs during the quarter also played its part in contributing to the bottomline growth.

Quarterly trend
(%) 2QCY05 3QCY05 4QCY05 1QCY06* 2QCY06 3QCY06
Sales growth (YoY) 28.8% 12.0% 5.4% 13.4% 9.4% 21.8%
Operating profit margin 25.4% 24.3% 23.3% 19.6% 21.7% 22.2%
Net profit growth (YoY) 54.7% 16.5% 15.7% - -18.3% 13.7%
* Net loss during the quarter

What to expect?
At the current price of Rs 399, the stock is trading at a price to earnings multiple of 13.8 times our estimated CY07 earnings. In the domestic market, biopharmaceuticals and in-licensing will be the key growth drivers for Wockhardt going forward. The company’s strategy in the domestic market is to increase market reach and penetration of existing products and focus on new product launches through the in-licensing route. In the US market, the company's focus on injectables will be the key, as this field has relatively lesser competition due to the complex technology involved and high level of investment required. Also, the company’s recent acquisition of Pinewood Laboratories is expected to enhance its revenues from the European region in the long-term. Benefits from this acquisition are expected to start filtering in from 4QCY06 onwards. Investors should note that we have not yet factored this acquisition in our estimates. However, pricing pressure in the US and German markets would continue to remain cause for concern. We maintain our positive view on the stock.

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