The principal shareholders must explain why the company is not pumping in more moneys into capex and why they are content with the company merely drifting along.
The Mallya link
The board of directors of Sanofi India is still chaired by guess who-Dr Vijay Mallya! But by God’s grace he has no control over the functioning of the undertaking. (The other connection of Vijay is the shareholding in United Breweries Holdings Ltd and United Breweries Ltd by Sanofi. But we will delve more on this shareholding aspect of the company later on in the copy). At least this is my understanding of the ground reality, and based on the brief 10 year financials that the company has appended to the annual report. The gross sales have grown to Rs 15.3 bn in 2012 from Rs 7 bn in the base year 2003 -an increase of 117%, while the profit before tax adopted a very zig zag route to rest at Rs 2.6 bn from Rs 1.45 bn over the same time span.
Vijay’s association with Sanofi derives from the erstwhile Hoechst Pharmaceuticals, the German pharma giant whose Indian operations were 40% owned by the UB group care of the late pater familias Vittal Mallya. The UB group subsequently sold their holding in Hoechst to Hoechst if my memory serves me right. A lot also happened subsequently in the global world of pharmaceuticals. Hoechst subsequently merged with Phone Poulenc of France to form Aventis. (Hoechst GmbH Germany is still a legal entity though and is the principal shareholder of the Indian offspring). In the meantime a company called Sanofi was founded by the French oil company Elf Aquitaine in 1973 which engineered a series of mergers and acquisitions of its own. Sanofi finally acquired Aventis but retained its name. The Indian unit in turn changed its name to Sanofi in 2012. The promoters - read as Hoechst and Sanofi together -- hold a slice over 60% of the paid up capital of Rs 230.3 m consisting of equity shares of the face value of Rs 10 each.
The Indian pharma market
The company states that the total Indian pharmaceutical market was estimated at Rs 712 bn in the calendar year ended December 2012. The company achieved gross revenues from operations of Rs 16.1 bn. After deducting excise duty, it toted up net revenues of Rs 15.7 bn. (The operating revenues include other operating income of Rs 92 m against Rs 120 m previously). Means its stake in the Indian market amounted to 2.3% on a gross basis and 2.2% on a net basis. In other words the company’s operations amounted to a mere flea bite in the overall Indian context. In reality its take in the Indian market is even lower if one factors in the export sales. Export sales at Rs 2.53 bn amounted to 15% of net sales by the company’s admission. If one deducts this amount, then the domestic penetration gets reduced to 1.9% on a net sales basis. It is indeed as pygmy alright. In reality I have to add another caveat. The sale includes bought items for resale. The company purchased traded goods (formulations) worth Rs 1.85 bn against Rs 1.35 bn previously. I do not know the value of rupee sales that the traded products generated as a result, as this information has not been separately furnished. In effect therefore the fixed assets to revenue from operations stand even lower.
It is also the first manufacturing company that I have come across where the bulk of the fixed assets constitute intangible assets. The total gross block at year end amounts to Rs 10.1 bn. The intangible assets in this total amounts to Rs 6.1 bn-or 60.4%. The vast bulk of this intangible asset block was apparently acquired in the preceding year when the merger took place. The intangible assets basically comprise of goodwill and brand. The constituents of the tangible assets also make for interesting reading. It almost completely comprises of buildings or plant and machinery. The two between them account for 88 % of the tangible gross block. Close to 52% of the tangible gross block was depreciated at year end.
The tangible assets generated revenues from operations 3.90 times its size. The gross block in totality generated revenues 1.6 times its size. That would not appear to make for much revenue generation on the face of it but that is the reality of the matter. Besides, the total addition to gross block during the year was a very paltry Rs 523 m against an even more miniscule Rs 259 m in the preceding year. Why the company is going slow in adding to its gross block is not known. This could also be a factor in its inability to rustle up a higher increase in revenues. It is not known what impediments the company is facing in its journey forward or whether it is deliberate.
Generous returns to the principal shareholders
Whatever, the foreign promoters must be more than happy at the returns that the company is providing to them. On net revenues including other income amounting to Rs 16.1 bn the company recorded a lower pre-tax of Rs 2.62 bn against figures of Rs 13.6 bn and Rs 2.84 bn previously. The decrease in pre-taxprofit was caused by a seemingly extraneous factor. The depreciation provision rocketed to Rs 899 m from Rs 311 m previously-due to the large addition to its intangible asset portfolio. (Given the massive accretion in the intangible asset portfolio by Rs 5.7 bn it is a bit surprising to note that the revenue expenditure on advertisement and sales promotion has increased only marginally to Rs 929 m from Rs 800m previously). Probably the acquired brands sell on their own. The post tax profit rested at Rs 1.76 bn against Rs1.91 bn previously. There are no interest charges as the company is completely debt free. The company declared a dividend of 390% on its paid up capital base of Rs 230.3 m. There is no reason for the principal shareholders to feel unhappy. As a matter of fact they appear so happy that they have not levied any royalty fees on the sibling. But then there are plenty other inter-se transactions with group companies.
The many tentacles of the parent company
The company expended forex worth Rs 4.4 bn and generated forex of Rs 3.2 bn during the year. So it was forex negative by a mile. The company makes do with 30 fellow subsidiaries. This includes four companies based out of India---Genzyme India Pvt. Ltd, Sanofi Pasteur India Pvt. Ltd, Shantha Biotechnics and Sanofi Synthelabo (India) Ltd. Sanofi India does not hold any shares in these fellow offspring. But as stated earlier it holds shares in two Mallya group companies. It holds 99,636 shares in United Breweries Holdings Ltd and 332,120 shares in United Breweries Ltd. One wonders what value the company sees in holding on to these shares given the lack of synergy between what it does and what the investee companies do. But these shares were acquired for a pittance and hence there is no carrying cost to the company. Besides, the market value of the shares was estimated at Rs 321 m at year end. It will of course come to Dr Vijay’s advantage when the management holding is toted up and at no cost to Dr Vijay.
But to get back to the point that I was extolling on. In the details of inter-se group company transactions Sanofi India sold raw materials and finished goods to group companies valued at Rs 2.48 bn while it in turn has bought the same items from group companies valued at Rs3.77 bn. It is not known whether all the finished goods that it has sourced are from group companies -but in all probability it was so. Then there is the sharing of ‘common expenses’ and ‘Income from Service’ rendered or for services paid which in turn run into the many hundreds of millions of rupees. Whether these transactions had a positive or negative effect or whether it was profit neutral on the company is not known, but presumably it was effected in the best interest of all concerned. This is a ‘burden’ that all MNC siblings have to contend with. One of the group companies, Shantha Biotechnics, was also a beneficiary of a corporate loan from the cash rich Sanofi India.
Whatever may be the shortcomings in putting the company in the all systems go mode, the company spins like a top. The cash flow shows an excess of cash riches at the end of the financial year. Cash and bank balances of Rs 4.28 bn at year end. Not surprisingly it has zero debt. The best part of the deal from the company viewpoint is that it does not have to splurge more than a few dimes on gross block addition. This frees a lot of cash for which the company has not found any profitable hideaways. How the company manages to sail by with such a pittance of any capital investment beats me totally-but that is the reality of the matter. It must he flogging its plant and machinery to the very ends of the earth for sure. The trade payables at Rs 1.5 bn towers over that of trade receivables of Rs 986 m. That in itself shows its clout in the market. And, for all practical purposes the company sells cash down. Only the inventories at 17% of gross revenues appear to be to on the higher side-in a manner of speaking that is. And, excluding the cash balance at year end, the current assets and current liabilities are almost on par.
But it would appear from the quivering manner in which the margins are generated that its major pharma products require the nod of the National Pharmaceutical Pricing Authority (NPPA) to obtain price increases and in such an exercise there is some delay between the lodging of the request and the sanction. Just as the NPPA sanctions price increases it also effects a reduction in prices.
But this is definitely not a company that would fit into the investment bracket notwithstanding the fact the share price (Rs 10 face value) ranged from a high of Rs 2,430 to a low of Rs 2,002 during the financial 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.