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Cipla Limited: On a growth drive - Outside View by Luke Verghese
 
 
Cipla Limited: On a growth drive

A company which appears to be constantly reinventing itself to generate the pace to get ahead

On an acquisition cum expansion spree

This is my second take on Cipla having first covered its working results for the 12 months ended March 31, 2011. Judging from the outlook that the company has painted in the directors' report to the shareholders it is safe to presume that the management is gung ho on its immediate future. The company has during the year completed the acquisition of 100% of the share capital of Cipla Medpro, South Africa, for a total consideration of Rs 27 bn. This company will apparently oversee the African operations. The consideration paid out is not small change by the standards that one applies for Indian companies. During the year it also set up an API (active pharmaceutical ingredient) R&D facility in Maharashtra and commenced the production of anti cancer APIs and anti ulcerant APIs at its Maharashtra unit. Then there is the unit to produce anti-retrovirals at the same facility. The company is simultaneously scaling up its API facilities at the Patalganga plant, and its anti-cancer formulations facility at the Goa unit. A new R&D facility is also in the offing at Mumbai. The total sum expended on capex during the year amounted to Rs 7.5 bn against Rs 5.5 bn previously. The vast bulk of the additions during the year have gone towards the setting up of 'buildings and flats' -Rs 4.16 bn - followed by 'plant and machinery' of Rs 2.96 bn. The company makes do with eight plant locations in the five states of Karnataka, Maharashtra, Goa, Himachal Pradesh and Madhya Pradesh, and one plant location in the Union territory of Sikkim.

The revenues and expenses

The company per-se generated gross revenues (including excise) of Rs 83 bn against Rs 70.7 bn previously-up 17.4%. The excise duty quantum however is minuscule. The makeup of revenues includes non-manufacturing sales inflows of Rs 1.9 bn against Rs 1.7 bn previously. The latter consists of export incentives, technical know- how fees, scrap sales, and rendering of services etc. After deducting excise taxes, the net revenues amounted to Rs 82 bn against Rs 69.7 bn previously or an increase of 17.5%--the same percentage increase recorded by gross sales. (The revenues include export sales of Rs 44.94 bn against Rs 37.3 bn previously. In other words the exports exceed the domestically generated revenues). Add to this revenue inflow 'other income' of Rs 2.3 bn against Rs 1.5 bn previously. One of the constituents of other income is the gain on forex transactions of Rs 867 m against Rs 667 m previously-a resource which cannot be quantified or depended on. (The value of imports and exports in toto amounted to Rs 58.1 bn against Rs 48.6 bn previously-a very significant sum). The other major resource in other income is 'dividend income' of Rs 906 m (Rs 363 m) which again is not necessarily a dependable source. It must be noted that 'other income' per-se also accounted for over 11% of the pre-tax profit against 10.4% previously-it is not something to be sniffed at.

The revenues include the value addition on the purchased traded goods worth Rs 7.1 bn against Rs 5.55 bn previously. (The company purchased goods worth Rs 3.26 bn against Rs 2.47 bn previously from group companies. The purchases amount to 46% of all purchases of traded goods against 45% previously. The company also sold finished products to its siblings but it is significantly lower than the purchases). The profit before tax clocked in at Rs 20 bn against Rs 14.2 bn previously - a significant rise of 41.5% one may add here. The significant factor for the disproportionate increase in pre-tax profit appears to be its ability to contain materials input costs. Such expenses amounted to 37.3% of net sales against a larger 41.1% previously. The other significant expense is 'other expenses' which grew 14% to Rs 20.5 bn-a rate of increase which is lower than the growth in net sales. One of the significant items of 'other expense' is professional fees which amounted to Rs 2.2 bn against Rs 936 m previously! One may also add here that on the face of it the company may have racked up significant 'gross margins' on the purchase / sale of traded goods. In 2012-13 the company could have generated a gross margin of Rs 3.1 bn on the sale of traded goods of Rs 10 bn.

A well managed ship

What is coming across quite clearly here is that even given the size of its operations including the many siblings that it has to support in terms of share capital outlays in them and any other favours that the parent may grant-it is a well managed ship. The book value of its investments in its siblings amounts to Rs 5.1 bn, and the year end loans advanced to them amounted to Rs 1.5 bn. Other favours granted if any are difficult to quantify. The company also spends large sums on 'research and development' though the schedule that it has appended on the R&D outgo is a trifle difficult to comprehend. The company generated a generous net cash flow of Rs 13.8 bn from operations during the year. Consequently, the purchase of fixed assets of Rs 7.5 bn was more than paid for from internal resources. It also involved itself in some generous purchase/sale of debt securities during the year. The gross purchases of securities amounted to Rs 187 bn while the gross sale value amounted to Rs 171.8 bn thus netting the company an additional net value of Rs 15.1 bn to its current investment portfolio.

The year-end cost price of its total debt portfolio amounted to Rs 20.8 bn. The company as stated earlier made some money on revenue account from this exercise--consisting of dividends on the one hand and the profit that it eked out on the purchase/sale of securities. (It may be noted here that none of the 17 siblings paid out any dividend during the year. So the dividends could only have accrued from its mutual fund holdings through the possible route of dividend stripping and from its holdings in two associate companies). In the context of the surplus funds at hand generated from operations -- why the company chose to add to its debt burden simultaneously is not quite clear. The year-end debt rose sharply to Rs 9.99 bn from Rs 372 m previously. The increase in debt has also to be seen in the context of the inter-corporate deposits that the company had lent out at year end. The ICDs' amounted to Rs 1.5 bn, though down from Rs 2.6 bn previously.

Current assets mismatch

Where it cannot exercise much control is in the composition of the current assets versus current liabilities mismatch. The current assets excluding the current investments amounted to Rs 47.5 bn while the current liabilities amounted to only Rs 22.6 bn. The two biggest constituents of current assets are inventories and trade receivables and together they constitute some 48% of gross revenues from operations. That is a lot of money to be locked up but apparently there is no second option in the matter. But even given this mismatch at the end of the day, the interest debited to the P&L account amounted to only Rs 334 m. The interest outlay in the current year may be much higher given the preponderance of debt in its books at end March 2013.

The siblings are a drag

In the context of the performance results of the parent, that of the siblings is in complete contrast. The results include that of the financials of 12 foreign siblings and five India based offspring. Some seven of the siblings have yet to open their innings on the revenue front. Fortunately, the ones which have opened their innings appear to be coasting along on the profitability front. It also includes financials on display which can be put on par with Aesop's fables. At least this is what I can make of it. The company with the biggest capital base is Meditab Holdings. It is quite obviously a holding company as the name plate suggests. It has a share capital base of Rs 1.6 bn, investments in companies-- other than in subsidiary-- valued at Rs 2.18 bn, NIL revenues and a profit before tax of Rs 1.14 bn. This appears to be a remarkable feat of financial engineering. How can a company report a mega pre-tax profit on NIL revenues? Even more remarkable is the performance statistics of Meditab Specialities. On a share capital base of Rs 60 m it has reserves of Rs 1.28 bn, and investments in companies other than in subsidiary valued at Rs 254 m. On revenues of Rs 390 m it generated a pre-tax profit of Rs 1.28 bn. On the face of it such financials are simply out of kilter. A company cannot generate profits in excess of its revenues-and in this instance the profits are far in excess of its revenues.

It is not known whether any of these companies are producing goods for sale. But given their asset bases it is more likely that they are buying finished goods for resale. The parent on its part has sold goods worth Rs 1.15 bn to the siblings against sales of Rs 2 bn previously. The 17 siblings collectively have generated sales of Rs 4.36 bn on their own. It is not known what value addition they have created on resale. The parent as stated earlier has generated export sales of Rs 44.3 bn which includes the sales made to its kith and kin. Given these statistics it does not pass muster why the parent has created so many siblings when the parent can execute the export sales on its own. But this is the reality of the matter. These creations appear to be more of an afterthought than for any value creation-which should be sole objective in the first place. These companies then are more of a blot to the otherwise sterling results that the parent has churned out.

Disclosure: I hold 1,187 shares in this company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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