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Merck Limited: Slow and steady Progress - Outside View by Luke Verghese

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Merck Limited: Slow and steady Progress
May 24, 2013

Being a member of a global conglomerate infers that the company will have little difficulty in remaining in business

A member of a humungous conglomerate

Hasten slowly is the mantra of this MNC pharma company with a Teutonic parentage. It is a part of large multinational agglomeration prevalent in more than 67 countries worldwide says the directors’ report to the shareholders. The Indian sibling on its part had transactions with some 25 fellow subsidiaries during the year including two Indian fellow subsidiaries---Merck Specialities Pvt. Ltd and Millipore India Pvt. Ltd. How it was possible to deal with as many as 25 fellow siblings given the figures that the company has furnished on this score is not known. Merck however says that drumming up export revenues is a bother given the parent’s vast tentacles across continents. But at the same time imports are not proving to be a hindrance whatsoever. The company generated forex revenues of Rs 802 m (including services rendered) while expending forex to the tune of Rs 1.9 bn-including services received. The forex revenues that it generated includes the sale of goods to its fellow subsidiaries and the parent company of Rs 528 m and the rendering of services to them of Rs 215 m amounting in all to Rs 743 m. The nature of the services rendered and the nature of the services received and the valuation of the services is not known. The forex expenditure on the other hand includes the purchase of goods from the parent and fellow siblings of Rs 865 m and the services received of Rs 383 m amounting in all to Rs 1.25 bn. The forex expenditure includes such exotica as professional fees, consultancy fees for IT support charges, and royalty. The purchases from the parent in all probability include the purchase of raw materials too. The value of raw material imports amounted to Rs 708 m.

Multiple inter-se deals

The point is that it is not known how the Indian sibling benefited from the inter-se deals with the parent and the fellow siblings. What for example was the net margin if any that the Indian company obtained from the sale of goods to group companies? What is the nature of the two way services agreement within the group?

There is however an interesting aside to these inter-se deals. As stated earlier the company purchased goods and received services from group companies. Similarly it sold goods and rendered services to group companies. The total values of these transactions are as stated above. But what is interesting to note is the year end dues and payables for such transactions. It owed only Rs 86 m at year end but the dues to it amounted to Rs 258 m. On the face of it, it would appear that it was paying its dues to group companies at a faster pace than it was collecting its dues from its group trade debtors. This is only an observation please.

Operating results

The net revenues for the year excluding other operating revenues rose 18% to Rs 6.58 bn. The revenues emanate from both manufactured and traded products -with the former accounting for 77% of gross sales and the latter the balance. The percentage concoction was the same in the preceding year. The revenues are buttressed by ‘other operating revenues’ of Rs 292 m on the one hand, and ‘other income’ of Rs 202 m on the other. The former is largely composed of income from shared services, and also from duty drawbacks, sale of scrap, and service tax credit. Is the first named in this sub-head some sort of an arrangement within the group and if so how does it operate? The latter head of income largely consists of interest income on loans and bank deposits, and tid bit dividend income from current investments. In the case of both such heads of incomes, the receipts cannot necessarily be counted upon for a repeat performance each year given their nomenclature-though it seems to be happening. The point is also that the two heads of income accounted for over 42% of pre-tax profit against a higher 51% in the preceding year. And that is not small change by any yardstick of measurement.

The revenues accrue from two main segments - pharmaceuticals and chemicals --and the pharma segment in turn as two business divisions namely Merck Serono and Consumer Health care. The pharma division accounted for 68% of revenues while the chemicals division brought in the balance. In this masala mix, traded products accounted for a slice over 23% of gross revenues, with the manufactured products bringing in the balance bacon. The items in the traded products constitute the same basket of items that make up the manufactured list. Why the company goes to the extent of outsourcing these products in favour of manufacturing them in-house is not readily known-but this is the reality of the matter.

Where the margins kick in

In the segmental information schedule the company gives the breakup of the margins that it has ratcheted up from the sale of pharma products and from the sale of chemicals. The company earned a segmental margin of 14.3 % from pharma sales and a segmental margin of 13% from chemicals sales. Not much difference here in the margins from the two product lines. The company has however generated decent margins on the purchase/sale of traded items. From my understanding of the figures the company would have generated a ‘gross margin’ of Rs 433 m in 2012 against a gross margin of Rs 375 m in the preceding year. But this calculation excludes the many other revenue expenses that go with such sales. So the net margin if any is not fathomable. Also not decipherable is the net margin that it would have realised from export sales. The problem is that the law as it stands today does not suffer any such odious requirement. Thus there is no way of knowing whether the minority shareholders are any the better off in the bargain.

Equity base out of sync with operations

Unlike other MNCs, the parent is also quite content holding 51.8% of the outstanding equity of Rs 166 m. This capital base is completely out of sync with the gross revenues of Rs 6.8 bn that it notched up in the latest year. That is to say for every one outstanding share the company generated gross revenues of Rs 410. That makes for a ratio of 1: 410. That would amount to a severe mismatch. Besides, the share capital is also backed up by humungous free reserves of Rs 4.67 bn. But there is unlikely to be any issue of free shares as the parent is quite comfortable with the satisfactory manner in which the company is chugging ahead. The parent in any case got to take home 51.8% of the dividend of Rs 41.5 m. Curiously enough the company does not appear to have declared a dividend in the preceding year though the post tax profits and the cash flow generation in that year would have warranted a dividend payment. One could infer from this that there does not appear to be any set dividend payout policy. It also got to take home Rs 126 m as royalty --before taxes that is -against Rs 104 m previously.

It also supports two fellow siblings with dollops of loans which fortunately carries a coupon rate with it. What exactly these two worthies -Merck Specialities Pvt. Ltd and Millipore India Pvt. Ltd-do is not known but Merck Ltd appears to have limited dealings with them. The inter-se dealings appear to be limited to the purchase of miniscule quantities of capital goods or some such.

Operating on a very sound wicket

Whatever may be the several infirmities about its functioning, the company operates on a very sound wicket. The gross fixed assets of Rs 1.65 bn generated a gross manufactured turnover of Rs 5.22 bn while the trade receivables of Rs 644 m accounted for 10% of revenues. The year-end inventories in either year accounted for 20% of gross revenues, and equally significantly the trade receivables was only marginally higher than the trade payables. Where the company needs to improve on if possible is to reduce the differential between the year-end current liabilities relative to the year-end current assets --excluding the sizeable cash balances at year end that is. But the difficulty here is in the inventory load that it has to carry. It has plenty of spare cash alright and it comes on top of the fact that it is also debt free. There are the loans to group companies of Rs 220 m, current investments of Rs 236 m, and humungous free cash of Rs 1.93 bn. The company seems to be a loss on how to deploy these surplus funds especially since the capex requirements each year are a relatively minor affair.

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 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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