Matrix Lab: Synergistic strides

Of late, Strides Arcolabs has been performing better than Matrix Laboratories

Matrix Laboratories, a Rs 640 crore company engaged in the manufacture of active pharmaceutical ingredients (APIs) and solid oral dosage forms, has approved the merger of Strides Arcolab with itself.

Strides manufactures pharmaceutical formulations in various forms and had a consolidated turnover of Rs 377 crore for the 12 month period ended March 2005. The move would enable the merged entity to offer integrated production facilities catering to overseas pharma players.

Matrix currently derives about 65 per cent of its revenues from APIs and its recent strategic alliance with the MCHEM Pharma Group in China coupled with other such partnerships in India have helped it achieve backward integration.

Strides' expertise lies in finished dosage forms, which means that the merged entity would be fully integrated and be present across the entire value chain.

Strides already has in place a number of international supply agreements with leading global pharma players for its finished dosages. The merged entity is expected to leverage the existing customer base with a wider product offering.

Expanding presence in the contract manufacturing business makes sense, since returns in the segment are pegged at between 15-20 per cent. In contrast, exporters of generics have been facing severe price pressures in the key American market.

Matrix itself was planning to scale up its contract manufacturing business from about 13 per cent of total revenues in FY05 to about 35 per cent in the next four years, according to analysts.

Interestingly, post the merger announcement, the Strides Arcolab stock jumped by 13.3 per cent, while the Matrix Labs stock rose just 1.3 per cent. The markets evidently believe that Strides shareholders will get a better deal.

As a result of the stock price changes, Matrix now has a market capitalisation that is 2.8 times that of Strides, compared with 3.1 times on Tuesday before the merger was announced. Matrix's net profit is 3.3 times higher than that of Strides, which explains its higher valuation.

But with Strides's share price rising at a higher rate, it now enjoys a higher valuation than Matrix. Strides now trades at 24.6 times consolidated earnings for the 12-month period ended March 2005. Matrix on the other hand gets a valuation of only about 21.2 times trailing 12-month earnings.

The valuation differential is surprising, not only because Matrix is a much bigger company but also because it enjoys much higher margins. In fact, Matrix's net margin of 20.6 per cent was almost double that of Strides's consolidated net margin. Lately, Strides has been performing better than Matrix.

In the quarter ended March 2005, it reported a 31.7 per cent jump in consolidated net profit on a sales growth of 12.5 per cent. Matrix, on the other hand, reported a 25.5 per cent drop in its net profit last quarter despite net sales rising by 12.66 per cent.

Matrix's profitability has been under pressure largely due to the pricing pressures faced for Citalopram, an anti-depressant. In addition, its staff costs have jumped 108 per cent or by 300 basis points as a percentage of sales.

Strides had said in its outlook for the year that it expects sales this fiscal to rise by 35 per cent and net profit to increase at a higher rate.

But this doesn't really justify its relatively higher valuation, since analysts expect even Matrix's earnings to grow by more than 35 per cent this fiscal. Speculation on these stocks based on what the merger ratio could be, therefore, is risky.

Maruti Udyog

Maruti Udyog has reported a four per cent drop in volumes for the second month in a row. Domestic sales grew 5.2 per cent or by 1965 units, thanks mainly to the 2981 units of Swift despatched post its launch late last month. The growth in domestic sales, as a result, was better than the 0.1 per cent growth recorded in April.

But the performance of the exports division was worse - exports fell 63 per cent or by 3891 units. This was the reason for the drop in overall sales. The company has already made it clear that in case of capacity constraints, it will give the domestic market preference and that exports would take a back seat.

But Maruti hasn't reached 100 per cent capacity utilisation yet. Its capacity stands at 6 lakh units per annum, which translates into a monthly capacity of at least 50000 units. May sales stood at 42286 units, which is about 15 per cent lower than production capacity. The high drop in exports, therefore, is a cause for concern, especially since it's happened for three months in a row.

It's not that domestic sales have been doing great. In the first two months of this fiscal, domestic sales have risen just 2.7 per cent. Also, sales of the key A and B segments (80 per cent of total domestic volumes) cumulatively declined during the period.

Most of the incremental volumes came from the C segment, which grew by 62 per cent during period. This segment accounts for just 6 per cent of domestic volumes, and can't really be expected to drive overall sales growth.

The launch of the Swift, therefore, couldn't have come at a more opportune time for the company. Analysts expect the new model to sell about 5000 units a month, which should help the company reverse the flat trend in domestic sales.

With contributions from Mobis Philipose and Amriteshwar Mathur