Cipla: Stay exposed

Recommendation: Stay exposed

Sanjiv Shankaran

A SIGNIFICANT jump in raw material cost led to a relatively modest growth in Cipla's net profit for the first half of 2001-02. The net profit grew 15.86 per cent over the corresponding previous period to Rs 104.83 crore.

For most pharmaceutical companies a 16 per cent growth in net profit should be creditable. But in Cipla's case, it appears modest considering its performance the last couple of years.

Strong sales continue

The growth of the domestic pharmaceutical market has been anaemic the last couple of years. Despite an unfavourable external environment, Cipla has been one of the few companies to record sharp sales growth. Cipla registered a sales of Rs 635 crore in the first half of this financial year, up about 24 per cent over the corresponding previous period.

The company's result sheet does not demarcate sales into domestic sales and exports. The distinction is crucial because the latter, that formed about 25 per cent of the total sales last year, is critical to its profitability. The company has indicated that export sales grew rapidly in the first half, thereby suggesting a favourable outlook.

One factor that helped Cipla register a strong sales growth is its ability to quickly introduce a range of new -- and often complex -- drugs. The versatile product basket helps Cipla offset a slowdown in growth in specific therapeutic segments and thereby protect the high sales growth.

Expenditure: Rising materials cost cause concern

Consumption of raw materials is the most significant expenditure for Cipla, generally about 45-48 per cent of sales. In the second quarter (July-September) of the first half of 2001-02, materials expenditure increased about 38 per cent. The sharp growth in the materials expenditure appears to have dented the growth in profit.

Profitability tapers a bit

Cipla's operating profit in the first half of 2001-02 was Rs 147.02 crore, up 13.31 per cent. The profitability of operations declined to 22.51 per cent of the total income from the 24.52 per cent in the corresponding previous period. The net profit for the first half was Rs 104.8 crore, up 15.80 per cent. The net profit margin trend mirrored that of the operating profit margin, declining to about 16.04 per cent of total income from 17.10 per cent in the corresponding previous period.

The earning per share (EPS) in the first half of 2001-02 was Rs 17.48, up 15.83 per cent over the previous period.

Outlook

Cipla is arguably the most competitive pharmaceutical company in India. Backed by a highly skilled research and development team, it has been able to take a lead in introducing new drugs. An emphasis on extracting more through process research has helped Cipla post handsome profit in an environment marked by a big slowdown in the domestic market.

The ability to compete successfully in a difficult market and strong process research skills have made Cipla one of the more highly valued pharmaceutical companies in the market today. The decline in Cipla's profitability in the period under review raises an important question: Will the company's growth begin to taper and thereby affect its equity valuation?

No, because the growing generic market in the US still holds promise for Cipla. Of significance is the possibility that an anti-ulcer drug, Omeprazole, holds for Cipla in the US. Cipla has an agreement with a US-based generic manufacturer, Andrx Laboratories, to supply Omeprazole bulk drug once the patent protection expires. The market for generic Omeprazole is huge and Cipla should benefit.

On the flip side, companies that hold a patent on a blockbuster generally exploit legal loopholes to extend the life of the patent, a factor that may lead to a delay in Omeprazole going generic. Therefore, it may not be the best time to start buying into Cipla. A decision on fresh buying can be taken once Omeprazole goes generic in the US.

It may be appropriate for shareholders to stay invested because the stock has some steam left. Therefore, it make more sense to hang on and await the outcome of the Omeprazole development in the US.

Pic.: (Right) Dr Y K Hamied, CMD and Mr Amar Lulla, Jt MD, Cipla Ltd.