Pharma: Signs of revival…

PHARMA

What does the analysis say?
The India story: The five companies posted a robust 29% YoY growth in total revenues during the quarter in question backed by a strong performance in the domestic markets. However, it must be noted that in the same period last year, de-stocking at the retailers’ level in anticipation of VAT had led to a sharp fall in revenues. As a result, part of the robust performance this year is due to the low base effect. That said, strong growth of existing products, especially in the lifestyle segments, and increased contribution from new product launches also contributed to the topline growth.
Exports scenario: Exports for the sector were a mixed bag. The generics market in the US continued to be plagued by increased competition and pricing pressure. Europe painted a mixed picture with Germany logging good growth rates in comparison to the UK, which was also prey to a competitive pricing environment. For example, while Ranbaxy’s US business grew at a double digit pace, this growth was largely attributed to increase in volumes. Companies following the contract manufacturing model like Cipla witnessed superlative growth in exports. In Cipla’s case, while formulations did record healthy growth, the impressive growth in bulk drugs (mainly supplied to the regulated markets) was the real show stealer. The semi regulated markets of Asia, Middle East, Russia and Africa continued to grow and contribute to the revenue streams of these companies.
Operating margins and profitability: Though margins on an overall basis expanded by 110 basis points, if one were to look at the individual snapshot, each had a different story to tell. Nicholas’ margin expansion was considerable, as it had reported a negative EBIDTA margin during the March 2005 quarter. Most of these companies witnessed a significant rise in raw material costs and R&D expenditure. Ranbaxy’s R&D expenditure (as a percentage of sales) declined, as the company has shifted most of its R&D in-house. Nicholas’ R&D expenditure increased after the acquisition of Avecia. The savings in costs for most of these companies was mostly on the ‘other expenditure’ front. Net profits of the sector grew by 30% YoY driven by strong topline growth, rise in other income and a lower tax outgo. Extraordinary items for the period included expenditure incurred by Wockhardt for due diligence of acquisition opportunities in the US.
What lies ahead?
While the fundamentals driving the generics market continue to remain strong, the brutal pricing environment is a cause for concern. It must be noted that the competition has tremendously increased, escalating the extent of price erosion. Having said that, while the competition most probably will show no signs of abating, a considerable rise in the patent expiries of blockbuster drugs in the coming years is likely to provide a breather to generic companies and boost revenues. The ability to manufacture drugs at the cheapest cost and leverage one’s marketing and distributing network to increase reach will be the key to survival.
We believe that partnerships are likely to play a crucial role in driving growth. This could be in generics (contract manufacturing, authorised generics) or research (R&D collaboration, contract research, out-licensing of molecules) or custom manufacturing for innovator companies. In the domestic markets, with the introduction of the patent law and subsequent slowdown of product launches, albeit at a gradual pace, companies entering into in-licensing agreements with innovator companies will have the upper hand. This will ensure a steady flow of product launches in the domestic market.

GLENMARK

Glenmark Pharma announced mixed results for the fourth quarter and year ended March 2006. For the fiscal, topline grew at a healthy double-digit pace led by a strong revenue growth in all the markets in which the company operates. However, operating margins witnessed considerable shrinkage on account of rise in raw material expenses. All these factors, coupled with a significant drop in out-licensing revenues, contributed to the decline in bottomline. That said, the fourth quarter numbers were impressive both at the topline and the bottomline level.

What is the company’s business?
Glenmark Pharma is a mid-sized company with focus on niche therapeutic areas of dermatology, gynecology, pediatrics and diabetics. The domestic formulations business contributed about 56% to the company's revenue in FY06. On the international front, while exports to the semi-regulated markets have been growing at a strong pace, the company is also looking to establish a presence in the US generics market and has entered into alliances with KV Pharma, Interpharm Inc, Konec Labs, InvaGen and Shasun Chemicals. The company is also focusing on R&D and has out licensed its lead compound for asthma to Forest Laboratories, US and Teijin Pharma, Japan in return for milestone payments.
What has driven performance in FY06?
International business is gaining traction: Glenmark’s topline grew by 23% YoY during the year led by a superlative performance of its formulations business in India, the US, Latin America and Rest of the World (ROW). Glenmark has completed its first year of operations in the US, and growth in this market was fuelled by the company’s newly approved generic ANDAs ‘Fluconazole’ and ‘Zonisamide’. During the year, the company filed 11 ANDAs and 16 to 17 products are currently pending US FDA approval.
In the Latin American markets, the Brazilian and Argentinean markets mainly contributed to the topline, resulting in a superlative 221% YoY growth in revenues. In Brazil, the company obtained registrations for 11 products and filed 19 dossiers with ANVISA in FY06. ROW recorded a 25% YoY growth with Glenmark obtaining registrations for 80 products during the year.
India shines: The domestic formulations segment posted a robust 30% YoY growth in revenues. Investors should note that part of this growth was due to the low base effect last year, wherein de-stocking at the stockists’ level in anticipation of VAT led to a considerably lower offtake. Besides this, introduction of 6 new products during the year also played a part in augmenting revenues.
Dismal API picture: While API revenues in the regulated and the semi-regulated markets globally grew by 20% YoY, a 31% YoY decline in the domestic API revenues pared growth, resulting in a 12% YoY decline in overall API revenues. The decline was mainly attributed to the decline in the first two quarters of the year on account of withdrawal of ‘Valdecoxib’ and price reduction of ‘Etoricoxib’.
Out-licensing revenues: Revenues from the out-licensing of the company’s asthma/COPD molecule ‘Oglemilast’ declined significantly in FY06. It must be noted that the completion of the Phase I clinical trials was delayed during the year resulting in non-receipt of the next phase of milestone payments. Having said that, the molecule has now completed Phase I clinical trials (entering Phase II) triggering the next milestone payment, which will now be due in FY07.
Huge margin contraction: A significant 690 basis points rise in raw material costs (as percentage of sales) led to the dip in operating margins, which fell by 750 basis points during the quarter. With staff costs also witnessing an increase, reduction in other expenses could not salvage the sharp contraction in margins.
It boils down to the bottomline: Despite a strong topline growth, bottomline declined by 15% YoY during FY06. This decline is despite a higher other income and lower interest costs. The company has attributed this decline mainly to the drop in the out-licensing income during the year.
What to expect?
At the current price of Rs 375, the stock is trading at a price to earnings multiple of 49.3 times its consolidated FY06 earnings. Glenmark’s presence in the regulated markets of the US and Europe is in its nascent stages. However, it has adopted the strategy of entering into alliances with companies, which is likely to give a boost to its US generics business going forward.
Similarly, the company has embarked on a strategy of increasing its presence in the Latin American and semi-regulated markets as well, which will further drive topline growth. On the R&D front, with ‘Oglemilast’ completing Phase I trials and moving into Phase II, Glenmark is awaiting the receipt of the next milestone payment for the same from Forest Labs (will accrue in FY07). Besides, it is also looking to find out-licensing partners for the same molecule in the European markets. The company also has 6 molecules under various stages of development, which could also turn into in-licensing opportunities going forward.

GSK Pharma

GSK Pharma has announced strong results for the first quarter ended March 2006 (January to December fiscal). For the quarter, the topline has grown by 54% YoY. The bottomline growth has, however, outperformed this growth in topline, backed by significant margin expansion and a rise in other income.

What is the company’s business?
Glaxo is the largest pharma company in the Indian market with a share of 6.5% (December 2004). It is a 49% subsidiary of the US$ 33 bn Glaxo Group, the world's second-largest pharma company with an R&D war chest of US$ 4 bn. Glaxo's product portfolio boasts of some of the leading brands like Augmentin, Zinetac, Betnesol, Cobadex and Zevit in the domestic pharma market. The company underwent a restructuring exercise and effect of the same was evident in 2003 and 2004. It derives its revenues from pharmaceuticals, animal healthcare and fine chemicals. In 2004, it successfully merged Burroughs Wellcome India with itself.
What has driven performance in 1QCY06?
Outpacing its peers: GSK Pharma clocked an impressive 54% YoY growth in topline in 1QCY06 propelled by its key pharmaceuticals business (85% of total sales) and outpacing its peers Pfizer and Aventis. However, investors should note that the topline performance should be viewed in context of VAT related issues, which had plagued the company and had led to a 23% YoY decline in revenues in 1QCY05. Besides this, the growth in revenues can also be attributed to a strong performance by its 30 power brands and contribution from new products launched last year.
As regards other businesses (animal healthcare and fine chemicals), we will not be able to comment on the performance of the same since the details are unavailable. That said, the management has approved the proposal for sale of its animal healthcare business in India (Agrivet Farm Care) to a leading European company for a total consideration of Rs 2 bn. This is subject to the receipt of the requisite approvals.
Sharp margin expansion: Tight wield over costs and an improved product mix contributed to the steep margin improvement by 740 basis points during the quarter.
Bottomline bloats: Bottomline recorded a superlative 116% YoY during the quarter backed by a robust growth in revenues and improvement in operating margins. A rise in other income has also played a part in contributing to the growth in bottomline despite a considerably higher tax outgo.
Over the last few quarters: Glaxo’s performance at the topline and bottomline level has been consistent, with the exception of the blip in 1QCY05, wherein overall performance was affected due to de-stocking by trade in anticipation of the introduction of VAT. The company’s efficiencies at the operating level can be gauged by the fact that on an average it has consistently maintained margins above 25%.

Aventis

Aventis announced strong results for the first quarter ended March 2006 late yesterday. While the topline grew at a healthy double digit pace led by its strategic brands, efficiencies at the operating level contributed to margin expansion during the quarter. Led by this and aided by reduction in depreciation and tax expenses, bottomline growth considerably outpaced growth in topline.

What is the company’s business?
Aventis Pharma, the 50% subsidiary of Aventis SA, France, is the second largest pharma MNC in India with a turnover of over Rs 8.1 bn (CY05). It is the eighth largest player in India with a market share of 2.9%. Aventis has relatively few but very strong brands in the country. Domestic sales constituted 72% of total sales in CY05 and exports constituted the remaining 28%. Over the years, it has progressively transformed itself into a company catering to the chronic (diabetes, cardio vascular) and critical-care therapeutic segments. Apart from catering to the Indian markets, Aventis supplies bulk drugs to its parent. In CY04, the parent merged with another France based pharma company, Sanofi, thus making it part of one of the largest pharma conglomerates in the world.
What has driven performance in 1QCY06?
Strong revenue growth: During the quarter, Aventis clocked a 15% YoY growth in topline, largely propelled by strong performance in the domestic market. Domestic sales (72% of total sales) grew by around 26% YoY on the back of a low base effect last year, wherein VAT related issues had a negative impact on the company (in line with the impact on the entire pharma industry). Besides this, the company’s leading brands such as ‘Amary’l, ‘Cardace’, ‘Clexane’, ‘Frisium’ and ‘Rabipur’ also contributed to the growth in topline. However, exports were the laggard this time, registering a 10% YoY decline in revenues.
Margins under pressure: Wielding a tight control over costs, Aventis’ operating margins expanded by 230 basis points during the quarter. Raw material costs, staff costs and other expenses as a percentage of sales witnessed a decline, thus contributing to the margin expansion.
Bottomline bloats: Bottomline grew at a faster clip than the topline and clocked an impressive 56% YoY growth during the quarter. This was largely due to margin expansion and a significant reduction in tax outgo. It must be noted that the effective tax rate reduced from 44% in 1QCY05 to 32% in 1QCY06. A rise in other income and fall in depreciation charges also played their part in contributing to the strong growth in bottomline.
Over the last few quarters: Barring a couple of quarters, Aventis’ topline has consistently grown by around 15% YoY. On the operational front, the company has managed to maintain margins above the 25% levels due to its focused business interest. We, however, expect Aventis’ margins to be under pressure going forward due to the fact that the company will not benefit anymore from the restructuring exercise that had helped expand margins in CY04.

What to expect?
At the current price of Rs 1,950, the stock is trading at a price to earnings multiple of 28.3 times its trailing twelve months earnings. In the domestic market, Aventis’ strong presence in the fast-growing lifestyle segment along with its focus on its strategic brands is expected to be the key growth driver going forward. Aventis, so far, has also been aggressive in launching new products and is therefore likely to be a major beneficiary in the patent regime when a slew of new products will be unveiled for the Indian markets. The company has undertaken several brand awareness initiatives over the years, which will augur well in terms of increased visibility for its products.