Ranbaxy Laboratories: A bitter pill

Pressure on margins was high especially towards the end of the quarter for Ranbaxy Laboratories

Ranbaxy Laboratories reported a 24.3 per cent dip in its profit before exceptionals and tax last quarter, despite a 28.2 per cent increase in sales.

Operating margin fell 540 basis points, mainly because of a 440 basis points increase in research and development expenses.

Most domestic players were expected to see a big growth in research and development expenses given the new patent regime starting in 2005, but the resultant drop in profit was not taken kindly by the markets.

The Ranbaxy stock fell about 6.5 per cent from its intra-day high of 1084.7 on Monday. The stock has declined 19 per cent since the beginning of the year.

Ranbaxy's domestic sales growth at 4.2 per cent was broadly in line with the market. Sales in the American market rose 19 per cent, but pressure on margin was high especially towards the end of the quarter.

The management pointed out that there was a reduction in generic margins across most product categories.

Given that background, it's important that Ranbaxy has grown sales in the European market by 139 per cent last quarter, especially since this market has not witnessed significant price pressure.

Its recent acquisition of France-based RPG Aventis has helped it expand its market share in the booming continental market for generics.

The company received 4 ANDA approvals in the December quarter and its cumulative product filing reached 146. But overall 2005 is expected to be a tough year for the generic industry with few product launches expected.

Moreover, the US generic market still accounts for over 40 per cent of the top line, which means margins would continue to be under pressure.

Ranbaxy expects sales growth to be in the mid teens in 2005, which means earnings growth could well be in single-digits. Keeping that in mind, the stock's valuation of around 23 times CY05 earnings is far from cheap, despite the correction in the stock this year.

HCL Info

HCL Infosystems' sales jumped up 96 per cent in the quarter ended December 2004, higher than the 89 per cent growth clocked in the September quarter. It's not even that the growth is coming off a low base "" sales had grown 65 per cent in the financial year till June 2004.

For perspective, HCL's sales grew substantially by 27 per cent on a quarter-on-quarter basis. The computer systems business accounted for only around 15 per cent of incremental sales (y-o-y).

The office automation and telecommunication business accounted for 84 per cent of the additional revenues last quarter.

Even on a sequential basis, this segment, which mainly consists of the Nokia handset redistribution business, accounted for a high 73 per cent of incremental revenues.

This segment, however, has margins of less than three per cent, compared with margins of 8-9 per cent for the computer systems business.

With the proportion of the lower margin business jumping by almost 10 percentage points, a fall in operating margin was inevitable.

But it's important to note that both segments themselves also reported a drop in profitability. As a result, operating profit growth at 36.3 per cent was much lower than the 96 per cent jump in revenues.

Investors don't seem to be complaining, what with the stock, now trading close to a all-time high, barely budging after the results were announced.

Also, it was expected that profit growth would lag revenue growth, what with a larger share for the low margin office automation and telecommunication business.

On a sequential basis, operating margin improved by 30 basis points. Although the HCL share trades close to an all-time high and has risen some 900 per cent since the rally began in April 2003, it still trades at less than 11 times estimated FY05 earnings.

This reflects the commodity-like nature of HCL's business, which has net margins of just about three per cent.

BPCL-Kochi Refineries merger ratio

Shareholders of Kochi Refineries Ltd (KRL) were disappointed at the ratio of 2.25:1 for its merger with its parent BPCL, with the stock crashing 16 per cent in intra-day trading.

The ratio is clearly in favour of BPCL, the ostensible reason being that the business outlook for BPCL-a refining-cum-marketer-is more favourable than it is for KRL, which is a pure refiner.

With Gross Refining Margins (GRMs) coming off sharply from around $8 a couple of months back to around $3-$4 currently, the view is that GRMs for Indian refiners appear to have peaked in the medium term.

The prospects for the marketing side of the business now look better, given that oil prices have come off but retail prices at the pumps have not been revised downwards.

While FY05 has been a washout, FY06 now looks better provided oil prices stay where they are. The merger itself will result in a saving of Rs 180-200 crore on the sales tax KRL used to pay.

KRL's net profit in FY04 was Rs 555 crore-of which 55 per cent (Rs 305 crore) was already consolidated with BPCL's earnings thanks to its 55 per cent holding in KRL.

Post merger, the balance Rs 250 crore will be added to BPCL's earnings, a 10.6 per cent accretion to its consolidated earnings.

The equity dilution at the same time is lower at around nine per cent.

With contributions from Mobis Philipose, Amriteshwar Mathur & Shobhana Subramanian