Cipla: Going ahead at full tilt - Outside View by Luke Verghese

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Cipla: Going ahead at full tilt
Oct 3, 2011

Cipla's renewed thrust on exports to get more traction on the revenue front, and its flurry of activity in corporate acquisitions as a part of this effort, does not appear to be very well coordinated.

Getting younger with age

The company is 75 years young as a corporate entity and for an Indian owned pharmaceutical company this is indeed a milestone to cherish. And the geriatric in age appears to be gaining traction as the years roll by. In 2010-11 for example, the company introduced a large number of new drugs and formulations - the company has given the names of 28 new items that it has put in the market. In April 2010 the company inaugurated its plant in Madhya Pradesh to manufacture pharmaceutical formulations (including aerosols, respules, prefilled syringes, nasal sprays, eye drops etc) at a total investment cost of Rs 9 bn. That is big ticket capex spending for a company like Cipla. In tandem it is setting up API (active pharmaceutical ingredient) facilities at Bangalore and Maharashtra, and is upgrading its API facilities at Patalganga - all at a cost of Rs 4 bn. And in a year in which the spending on capital assets and in its investments portfolio together toted up to Rs 9 bn, the borrowings rose far less 'impressively'- by 4.3 bn.

More importantly, the company states that almost 55% of its total income, or Rs 33.6 bn, originated from international markets in the latest completed year. (It may be noted that there was also heavy dependence on imports of raw materials and packing materials to the tune of Rs 11.7 bn). It also claims that it has strategic marketing alliances and partnerships in more than 170 countries! That is a big number for sure. To round out the picture it also acquired 12 subsidiaries/ step down subsidiaries during the year. All in all it makes for a very pretty picture, alright. One may add here that close to 95% of the company's paid up equity of Rs 1.6 bn is made up of bonus shares. It is of course another matter that the paid up equity is totally out of sync with its accumulated reserves and surplus of Rs 64.5 bn, or with that of its net revenues including other income of Rs 64.3 bn for that matter.

Profitability under strain

The company achieved a 14.4% increase in net sales, including exports at Rs 61.4 bn during the year. It also dabbles in bought out sales with purchases of finished goods amounting to Rs 6.7 bn against Rs 6.2 bn previously. Other income however dropped to Rs 3 bn (export incentives of Rs 1.2 bn and technical know fees of Rs 637 m) from Rs 3.5 bn previously. But with material, employee, and operating costs, rising faster than the growth in net sales, the pre-tax profit fell 6% to Rs 11.5 bn. The sharpest increase of the three items was in employee costs which rose 45% to Rs 4.6 bn. Why should this be so? There is no explanation forthcoming for this in the body of the annual report and accounts. The post tax profit slid 11% to Rs 9.6 bn after making the myriad provisions as prescribed by law under regular tax, MAT (minimum alternative tax) and deferred tax. This fall in profit makes for perplexing deductions, as the company has profoundly stated in the directors' report that export revenues now account for over 55% of total revenues. Is one to understand therefore that export sales are being jacked up at the cost of the bottom-line? What is the long term plan here please? Are the new capacities coming on stream a part and parcel of the increased export effort? Another reason for the strain in profitability is that the year-end debtors and the inventory balances account for 30% and 24% respectively of the gross sales for the year. To the good fortune of the shareholders though, being the platinum jubilee year the board loosened its purse strings a bit and made a higher dividend payout amounting to 27% of post tax profits, against 19.6% previously.

Revenues not commensurate with capex spend

Given the big ticket spending on productive capital assets that the company has put on stream, the top-line growth appears as yet to capitalize on the bonanza waiting to be exploited. The company classifies the goods that it makes under the seven sub heads. They include bulk drugs, tablets and capsules, liquids, creams, aerosols, injections and 'Others'. The individual contribution to revenues by each of the product lines along with sundry other details in this regard is not known, as the company has been given an exemption from doing so, due to its branding as an 'export house'. It is difficult to understand the logic, if any, that The Ministry of Corporate Affairs could have conjured up for granting disclosure exemptions such as this, but the point is that companies are quick to pounce on such freebies to hide basic data.

In any event the product lines which have seen an increase in capacities are that of tablets and capsules where the production capacity grew by 5% to 17,496 m units, and liquids where the capacity rose by 137% to 3,192 kilolitres. The capacity of its Aerosols unit grew by 50% to 144 bn units, while that of the injections business rose 49% to 1,739 Kilolitres. The item labeled 'Others' has no installed capacity, yet it manufactured 2,061.7 whatever! This is magic at its very best. Interestingly enough the capacities of two items, Bulk drugs and Creams, actually declined during the year, for which no explanation has been forthcoming. It is of course anybody's guess the individual contribution to revenues of the different manufacturing lines.

Ironically, the sharpest rupee percentage increase in production, by 368% at that, was registered by 'Others'. It will be nice to know what rupee figures this translated into. Some of the production figures do not cut much ice on the face of it. Take for example Bulk Drugs. Its installed capacity as stated earlier fell 20%, but the production of bulk drugs grew 22% to 1601 tons - way above capacity. How the heck is this possible? The capacity to make aerosols has been hiked sharply, but the production has merely inched up by 4% to 55 bn units. There are several other anomalies like this. But to be fair the company has appended a general foot note to explain the aberrations.

Acquiring the many accouterments of adulthood

Having come of age by its own assessment both in terms of age and size, the company has acquired the many accouterments of adulthood all too suddenly. The acquisition of three of the four subsidiaries (acquired during the year) was at a capital cost of Rs 3.3 bn and it also came with an added icing. The company had a year-end loan of Rs 2 bn due from them. The total value of its investment in its four direct subsidiaries totes up to Rs 3.4 bn. Its biggest outlay is in Goldencross Pharma which was acquired for a price of Rs 1.9 bn or a per share acquisition price of Rs 416 against a face value of Rs 10. Next in line is Meditab Specialties with a total investment outlay of Rs 1.3 bn, and a per share acquisition price of Rs 2.2, against a paid up value of Rs 1 per share. (The acquisition price per share of the two companies is starkly different). The sibling based out of Dubai at the Jebel Ali Free Zone was acquired at a per share price of Rs 12.5 m, though thankfully the total acquisition price was limited to Rs 187 m.

In actual fact the company makes do with four direct subsidiaries, nine 'step down' subsidiaries (six of which are based out of other countries), five associate companies (four of which are based out of other countries), and another six pharma companies (base not known) in which key management personnel exercise significant influence. The step down subsidiaries, and the associates, like three of the four direct subsidiaries, were all acquired during the year, which is quite an over-achievement by itself. Incidentally, its subsidiaries and step down subsidiaries are all 100% owned. In three of the five associates however, it has a 'minority' holding going by the statistics available-ranging from 49% to 34%. None of these associates belong to the joint venture category, though. It has not given any information on the holding pattern in two of the five associates, and they are based out of Shanghai, China. The important point to note here is that the parent does not directly hold any shares in the associate companies, but they are deemed associates nevertheless. Then there are the six other companies which possibly are owned by the 'family'.

What is interesting in this make up is that the parent bought goods worth Rs 2.3 bn from its subsidiaries, and bought goods worth Rs 1.9 bn from its associates. It also sold goods worth Rs 209 m to its subsidiaries, and sold goods worth Rs 1.5 bn to its associates. It also paid processing charges of Rs 530 m to its subsidiaries. It appears to have a weakness for its associates.

Inadequate disclosures

The parent does not appear to have furnished the brief financials of the direct, and step down subsidiaries, as required under Sec 212 (8) of the Companies Act relating to subsidiary companies. Neither does it appear to have appended any reasons for not doing so. It would have been interesting to see from the figures what this sudden hullaballoo in acquiring subsidiary companies was all about. But there is a puzzling pointer to the state of affairs. The consolidated profit and loss account states that the total revenues from 'sales and other income' during the year were Rs 64.2 bn against Rs 64.3 bn for the standalone company. The pretax profit for the consolidated entity was Rs 11.6 bn against Rs 11.5 bn for the standalone entity. This difficult to digest set of figures is enough to give one a migraine.

As one can see it is very difficult to make any sense of all this.

Disclosure: I hold 1,187 shares in Cipla Limited

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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