Novartis: Demerger dose takes effect

The Novartis stock has been at the receiving end over the past one week. The stock hit a 52 week low of Rs 501 yesterday. The primary reason seems to be the adjustment for the spin off of its agrochemical unit. This is in line with the proposal of its international parent Novartis AG to separate its agrochemical arm. This would then be merged with the agrochemical arm of Astra Zeneca to form a new company Syngenta. In India too the same process is underway.

The healthcare business (includes the vision care division and the animal health division) is not an asset heavy business since Novartis India outsources most of its production. The top eight brands of the company contribute almost 49% of its formulation sales.

The overall operating margins (excluding other income) of the company, which were around 17% can be expected to increase to around 20% post the hive off of the agrochemical division. Infact, even in the current year first half results, if one were to exclude the pre–tax sales and profits of the agribusiness the pre–tax margins (excluding other income) improve from 9.81% to 11.7% in the current year itself. Also, the company would be able to reduce its working capital requirements since the inventory days and debtors days can almost be halved from the present levels of 70 days and 55 days respectively.

Consequently, the return on equity would zoom to nearly 35% in FY2001 post hive off. (It stands at 31.6% currently.) Besides, the company has launched five new products over the last two years, all of which are out of the purview of the Drug Price Control Order. This can be expected to improve the margins further.

The improvement in profits, the removal of a seasonal business, the introduction of new products coupled with the almost zero debt status of the company should spell good times for the company. The stock quotes at Rs 501, which implies an earning multiple of 29 times its estimated FY01 earnings.

Another trigger for the stock could be a sizeable sum which would be received from the grant of development rights at its real estate in Goregaon (a suburb of Mumbai). Last year, the company granted development rights on this real estate and this fetched the company an amount of Rs 66 m. (Novartis’ real estate can fetch it Rs 1.50 bn if it were to give development rights for its entire estate.)

The only possible dampener to the stock valuations could be the presence of two 100% subsidiaries of the parent, which would be used to launch nutritional products in the future..