• OCTOBER 30, 2004

Novartis: Growth not visible

Introduction to Results
MNC pharma company, Novartis India, declared its 2QFY05 and 1HFY05 results yesterday. The topline of the company has registered a marginal growth in the quarter. However, the bottomline saw a decline of 18% owing to lower other income and higher tax expenses on a YoY basis. The poor performance of the bottomline is despite an operating margin expansion of 780 basis points.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 1,245 1,254 0.7% 2,573 2,572 0.0%
Expenditure 1,098 1,009 -8.2% 2,242 2,067 -7.8%
Operating profit (EBDITA) 147 245 66.9% 331 505 52.8%
Operating profit margin (%) 11.8% 19.6%   12.8% 19.6%  
Other income 218 96 -55.8% 299 163 -45.6%
Interest 2 2 -5.6% 4 3 -20.5%
Depreciation 39 13 -66.1% 77 26 -66.1%
Profit before tax 325 327 0.7% 549 639 16.3%
Tax 60 110 82.4% 109 210 93.5%
Profit after tax/(loss) 265 217 -17.9% 441 429 -2.8%
Net profit margin (%) 21.2% 17.3%   17.1% 16.7%  
No. of shares (m) 32.0 32.0   32.0 32.0  
Diluted earnings per share (Rs)* 33.1 27.2   27.6 26.8  
P/E ratio (x)         21.6  
(* annualised)            

What’s the company’s business?
Novartis is a leading player in certain therapeutic segments, with strong brands like Voveron, Tegrital and Calcium Sandoz. The company has a strong presence in anti-TB, respiratory and anti inflammation segments. Also, it has a very strong parent back up which is dedicated towards research work and has consistently introduced new products in different therapeutic segments. However, it has a no manufacturing operations in India and all the products that Novartis sells are either out-sourced from the local producer or imported from the parent company. Thus, this company should be seen as a trading company rather than a drugs manufacturing company. This puts a question mark on the company’s seriousness about the Indian market.

What has driven performance in 1QFY05?
Sales: The sales of the company recorded a marginal growth owing to modest growth in pharma and OTC businesses, and a fall in revenues from the Generics business. The animal health care segment also saw a modest growth of 3.3% in the quarter. The sales in the animal health care segment fell in the recent past as the company has discontinued one of the top selling product ‘organophosphorus’. The generics business continued to decline in this quarter too. However, company's focus on the OTC segment helped it to grow by a modest 3.3%, but is likely to gain momentum going forward as the company has strong focus on this business segment. The growth in the pharmaceutical segment seems to be marred by the reduction in prices of TB drugs. However, the company is now targeting tier II / tier III cities and towns in the country to diversify its revenue base geographically. This initiative, though time consuming, will improve the company’s revenue growth going forward.

Segmental revenue share Sales   PBIT Margin
  2QFY04 2QFY05 Change 2QFY04 2QFY05
Pharmaceutical 774 790 2.0% 17.2% 27.7%
(as % of total sales) 62.2% 63.0%      
Generics 288 275 -4.5% 3.1% 11.8%
(as % of total sales) 23.2% 22.0%      
OTC 111 115 3.5% -6.4% 10.6%
(as % of total sales) 8.9% 9.1%      
Animal Health 72 74 3.3% 12.6% 4.0%
(as % of total sales) 5.8% 5.9%      
Total 1,245 1,254 0.7% 11.6% 21.2%

Operating margins: Despite a marginal topline growth, the operating margins of the company has expanded by 780 basis points. This could be attributed to better sales mix as the company is focusing on improving its sales mix since last few quarters. The raw material costs have come down significantly in the quarter and also the costs involved in the purchase of trading goods have also come down. The staff cost, however, has risen by 5% due to company increasing its sales force for expanding geographically.

Cost break-up
  1QFY04 1QFY05 Change
Raw Material 29 42 44.9%
(as % of sales) 2.6% 4.1%  
Staff Cost 108 114 5.2%
(as % of sales) 9.8% 11.3%  
Purchase of Traded Goods 609 548 -10.0%
(as % of sales) 55.4% 54.3%  
Other Expenditure 353 305 -13.4%
(as % of sales) 32.1% 30.3%  
Total 1,098 1,009 -8.2%

Net profit: Despite good performance at the operating level the net profit of the company has fallen by 18%. The major reason for fall in net profit is lower other income. During 2QFY04, the company booked a profit from sale of some of its property, this effect is missing in 2QFY05 and this has led to lower other income. However, if one excludes the effect the net profit has actually grown by about two and half times. Also, higher provision for tax has kept a check on the net profit.

What to expect?
At Rs 578, the stock is trading at 21.6x its annualised 1HFY05 earnings. Novartis is a leading multinational pharma company with some strong brands. Historically the valuations of this company have been at a discount to its peers for reasons such as lower penetration in the markets and absence of manufacturing activity. However, the initiative taken by the company to expand geographically augurs well for the growth of the company going forward. Also, with the new patent regime the company will be in position to launch new-patented products in the Indian markets giving a further growth avenue for the company. The company is pretty clear about launching new products and is revamping its operations for the same. However, till that time Novartis will be seen as a trading company and will enjoy a lower valuation compared to top MNC pharma companies.

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