Abbott India is a pure play pharmaceutical company which has been operating in the Indian geography for over 67 years now. But judging from the ten year financial highlights it has displayed, it would appear that it has still to come to grips with managing the environment. Consider the following data. In the year 2001 (for an operating period of 11 months) the company forked out a gross turnover including other income of Rs 3.3 bn while recording a profit before tax of Rs 645 m. In 2010 (for an operating period of 13 months) the turnover had rocketed to Rs 10.3 bn, but it could manage a pre-tax profit of only Rs 941 m. Okay, the profits for 2010 took a knock due to some extraordinary expense items (salaries/advertising/travelling expenses) but it still says something about the inability of the management to come to grips with the task on hand. While the turnover has almost shown a steady increase in each of the 10 years, the pre-tax profits has suffered a bumpy ride right through. The CEO was richer by Rs 30 m during 2010 for running a ship which is springing leaks on the profitability front.
One point that the management got right is in possibly engineering a buyback of shares with Abbott India's monies, which in effect reduced the paid up capital from Rs 162 m to Rs 137 m over the ten years. This buyback also led to the promoters (read as Abbott Capital India Ltd, UK) increasing its holding in the Indian sibling to a little under 69% of the outstanding equity. The present paid up equity is relatively miniscule relative to the scale of its operations. This capital base is backed up by reserves of Rs 2.9 bn. The company is also debt free, follows a conservative dividend policy, and is cash rich to boot (Rs 1.9 bn cash balance), but given the manner in which it generates its business this is not surprising.
How it rustles up its top line
The company manages with a gross block of Rs 1.2 bn, and one manufacturing facility, with the factory being located at Goa. In 2009 the company added Rs 79 m to gross block, increasing the spending marginally to Rs 121 m in 2010 (excluding any sales of gross block). The turnover is a combination of both manufactured and bought out sales. It would appear from the evidence available that bought out finished goods sales are significantly greater than manufactured sales. The company outsourced finished goods worth Rs 6.3 bn (juxtaposed against a gross turnover excluding other income of Rs 10.4 bn), and it also outsourced raw materials for resale. The bought out sales covers the entire spectrum of goods that it sells - tablets/capsules/liquids/ointments/injectables/powders. The company on its own makes only tablets and liquids. That is to say the entire sales of capsules, ointments, injectables and powders are outsourced. What is interesting here is that the bulk of the outsourced sales are sourced locally. In value terms only 6% is sourced from Abbott group companies, including from Abbott Healthcare India Pvt. Ltd (where the latter company fits in, in the overall scheme of things is not known. There is also another Indian connection through Solvay Pharma India Ltd, which too like Abbott Healthcare is a fellow subsidiary). But the interaction between the group companies has led to Abbott India finding itself in the driver's seat. The other income schedule has a receipt of Rs 167 m, (Rs 109 m previously) being income from fellow subsidiaries. According to one of the schedules this receipt is on account of shared services - would that make it a reimbursement of expenses?
From where it generates its margins
The company does not furnish separately the margins that it earns from its outsourced sales, but since some of them are completely outsourced one can indulge in some math on this score. Outsourced sales apparently add considerably to the bottom-line given the mark-ups that the company is able to muster on its purchase cost. Injectables sales are by far the biggest business both volume wise and value wise. The other items on offer - capsules, ointments and powders which are also completely outsourced, have a relatively minor contribution. 60% by volume of tablet sales are outsourced as is 40% by volumes sales of liquids. On the combined sales of injectables, capsules, and ointments amounting to Rs 5.4 bn, the company would have pulled in a gross margin of Rs 542 m. Such sales accounted for close to 55% of all sales. Given the overemphasis on earning its bread and butter from outsourced sales it is quite reasonable to assume that manufactured sales are a laggard in the bottom-line department. And very creditably the company was able to continue selling cash down even in 2010 when the rupee sales accelerated by over 30%. Which brings one to the point of how the company was able to create so much of additional demand for its products overnight?
The overdrive in the expense department
The problem on the bottom-line front was that the company went into overdrive in 2010 on the expenditure side of the P&L account. (This led to a 20% dip in pre-tax profit to Rs 941 m from Rs 1.2 bn previously.) The staff strength was augmented by 35% and this in turn led to a 78% increase in the overall wage bill to 1.1 bn from Rs 623 m previously. In consonance, the company also ramped up expenditure on advertising and publicity by 104% to Rs 487 m and more staff also meant an increase in travelling expenses by 74% to Rs 272 m. The management says that ‘expanding the sales force was to improve market coverage and enhanced promotional efforts to increase market share resulted in a strong increase in sales'. It is quite obvious that any increase in sales in future will come from bought out finished goods than from manufactured sales. As a matter of fact the volume production of tablets and liquids in 2010 was lower than that in the preceding year. Volume sales of traded goods on a comparable basis however accelerated 24%.
In this context of overdependence on bought out finished goods for its sustenance, the directors' emphasis on the R&D (research and development) effort appears to be grossly overblown. The annual report states that a well focussed R&D effort has helped the company in launching a number of new products in the Indian market. It goes on to add that R&D activities will continue to focus on new product development, and improvement in existing formulations etc. If any R&D effort is indeed taking place then it is definitely not happening in Abbott India. For, the same page says that the total expenditure on R&D, both on capital and revenue account in 2010 was a princely Rs 18.6 m! What in heaven's name can expenditure of this magnitude achieve in the R&D arena?
The year to come
Assuming that the company can maintain the tempo in growth in sales in 2011, and it is able to neutralise the increase in personnel and advertising costs etc as a result, then the company should be on song in the current year.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. 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.