Cipla: Low-risk strategy pays off

Partnership model helps Cipla expand operating profit margin

Cipla's September quarter results once again demonstrate the efficacy of its exports strategy, which primarily involves a partnership-based model.

No doubt, the model limits profit expansion as it has to be shared with overseas partners, but it is also viewed as a low risk model, as the company avoids large marketing and allied costs.

As a result, operating profit margin (OPM) expanded 368 basis points to 26.37 per cent in the September quarter. Sequentially too, operating margins expanded 406 basis points.

Other large generic players such as Dr Reddy's Laboratories have also used the model to manage R&D costs and it helped consolidated OPM expanded 685 basis points y-o-y to 20.15 per cent in the September quarter.

In contrast, Ranbaxy, which has been relying on winning patent litigation, had earlier seen its EBITDA margins fall by a staggering 2064 points y-o-y to just 2.31 per cent in the last quarter.

Cipla's exports have jumped 32.63 per cent y-o-y to Rs 320.5 crore in the September quarter and that was largely on a surge in its formulations business.

Formulation exports at Rs 248 crore in Q2 FY06, have grown 57 per cent y-o-y and that was largely owing to higher dispatches of budesonide inhalers to Germany, ahead of the winter season, point out analysts.

It is commendable that exports accounts for nearly 47 per cent of total sales of Rs 684.1 crore in the September quarter. In Q2 FY05, exports, as a percentage of total sales, was almost 40 per cent.

Meanwhile, domestic sales were around Rs 363.5 crore on a y-o-y basis in the last quarter. It is understood that this was owing to torrential rains in late July in Mumbai, which damaged stock worth approximately Rs 100 crore at the company's warehouse at Bhiwandi. The company has filed necessary insurance claims for the loss.

Like other players, operating costs, such as staff cost, has grown 15.6 per cent y-o-y to Rs 30.3 crore in the September quarter. However, an improved export performance has helped operating profit expand almost 26 per cent to Rs 177.26 crore in Q2 FY06.

In contrast, Ranbaxy reported a loss of Rs 15.4 crore at the pre-tax level last quarter. Going forward, Cipla is expected to push exports of inhalers to Europe in the medium term.

However, the street appears to have factored in the growth opportunities, given that the stock trades at almost 22.5 times estimated FY06 earnings.

Tyre woes

Domestic tyre companies could once again have to grapple with rising input costs, as rubber prices have increased considerably over the last one month.

That's because supplies from key producing countries such as Thailand and Malaysia, have shown signs of being constrained owing to heavy rains in several parts of south-east Asia over the last few weeks.

Also, domestic supply of rubber has also lagged behind demand "" domestic production between April and September 2005 was 3.40 lakh tonne compared with a requirement of 3.97 lakh tonne. As a result, spot rubber prices have risen about 7.1 per cent to approximately Rs 68 a kg over the past one month.

In contrast, spot rubber prices, were showing signs of stabilising at about Rs 60 a kg in mid-September. Inputs costs such as rubber typically account for 65 per cent of net sales of a tyre company.

Higher input costs has led tyre stocks to underperform the Sensex over the past one month "" Apollo Tyres, for instance, has fallen about 10.2 per cent compared with a 7.2 per cent dip in the broader market.

Apollo Tyres has grown its operating profit by 277 basis points to 9.38 per cent in the September quarter, thanks to net sales expanding 24.65 per cent y-0-y to Rs 632.78 crore.

Higher input costs has resulted in raw materials, as a percentage of net sales, expanding almost 343 basis points y-0-y to 67 per cent in the September quarter. However, a cushion on margins has been provided by the decision of most tyre firms to retain about half of the reduction in excise duties, that had been announced in the last Union budget.

The budget had earlier reduced excise duties on tyres from 24 to 16 per cent. As a result, the company's operating profit expanded 76.91 per cent y-o-y to Rs 59.39 crore in Q2 FY06. The stock does appear reasonably priced at about 13.9 times estimated FY06 earnings, given the rising cost base of the company.