Except for Cipla and Glaxo which are impacted more by the slowdown in the domestic market, analysts expect an improvement in sales and EBITDA quarter-on-quarter for other pharma companies in the industry, says Nomura in its research note
The growth in the India pharmaceutical market is adversely impacted by trade
destocking. Though Dr Reddy’s has benefitted from a lower base in the previous quarter (the increase in sales towards the end of Q1FY14 due to the resolution of agitation by chemists in Maharashtra was accounted for fully in Q1FY14 numbers), the ongoing tussle between the trade and pharmaceutical companies regarding trade margins is likely to impact the growth adversely, according to Nomura Equity Research in its note on the pharmaceutical industry performance. Analysts accordingly factor in -3% growth in the industry. There is also a drop in prices as per the new pricing policy.
The key characteristics of the quarterly performance of the pharmaceutical industry are: a) a slowdown in the domestic formulation business due to the implementation of the new pricing policy and tussle with the trade on margins; b) key high value launches in the quarter, particularly by Dr Reddy’s and Sun Pharma; and c) rupee depreciation against key export currencies, points out the Nomura research note.
Except for Cipla and Glaxo which are impacted more by the slowdown in the domestic market, Nomura analysts expect an improvement in sales and EBITDA quarter-on-quarter for other pharma companies.
Nomura analysts expect the industry to record a consolidated revenue growth of 14.4% and EBITDA growth of 15.5% in 2QFY14F.
In its overall analysis of all companies in the sector, the research note says that medium-term growth drivers that include the US and India opportunities are intact for the sector. Further, rupee depreciation presents additional tailwind, concludes Nomura.
The Nomura research note estimates for the sector are given in the table below:
Weakening real activity has meant that top-line growth has been in freefall, dragging down profits along with it, says Nomura Equity Research in its research note on September quarter earnings preview
Net sales of Indian companies have been growing at an ever-slower pace over the past three years due to external considerations like inflation, depreciating rupee etc., according to a research note on September quarter earnings preview by Nomura Financial Advisory and Securities. This observation is clearly shown in the graphs below:
With topline growth falling, the bottomline has been under pressure in most companies. Nomura sums it up with the remark, “Weakening real activity has meant that top-line growth has been in freefall, dragging down profits along with it.” This observation is shown in the graphs below:
Sectors with high operating and financial leverage have to live with increasing pressure on operating and net profit margins, warns Nomura in its India Equity Strategy note. Industries facing domestic economy continue to remain a drag and are expected to make negative contributions to aggregate profit growth in the quarter.
The bright side of the problem has been that while competition has put margins under pressure, significant relief from weak raw material prices has been an important offsetting factor in protecting sequential downside to gross margins; Nomura notes that despite being in freefall, net sales growth has exceeded cost of goods sold growth over the past five quarters.
Even though recovery is expected soon, there is a warning that it may not benefit all investors in the stock market. Recovery is not broad-based - a large part of the year-on-year growth in market aggregates is on account of a handful of exporting sectors, beneficiaries of a depreciating rupee and the nascent global economic recovery. More specifically, excluding non-PSU oil & gas, autos (led by JLR), IT services and pharma from aggregate numbers: net sales growth falls from 14.1% to 8.6%; operating profit growth falls moderately from 15.5% to 13.3%. Net profit growth falls from 9.4% to no growth, points out Nomura.
Sector-wise performance and forecast is shown in the graph below:
The research note concludes that as the market recalibrates its expectations of a rate cutting cycle in the face of improving current account deficit numbers and the potential delay of the Fed taper (in light of the negative implications of the current fiscal impasse in the US0, valuation does not offer much comfort. The 12-month forward consensus-based earnings multiple for the market is currently at 13.2x (versus a five-year average of 14.3x) is not encouraging given the negative outlook on growth, with possible exception of upside from export growth.
The percentage change in corporate earnings for Sensex companies during the last quarter is shown below:
Cairn has recently approached the government seeking permission to a swap arrangement with Indian Oil Co whose refineries are in a position to use low sulphur crude
After acquiring the Rajasthan block from Shell in 2002, Cairn made the first oil discovery in 2004, when ONGC came in as a partner with 30% stake. Now, Cairn produces about 180,000 barrels a day (bpd) and has plans to reach 200/215,000 bpd after receiving some clearances from the government which are awaited.
Once regulatory approvals are received and additional investments made, 35% of India's crude requirement will be met from Cairn-ONGC fields. This will take the production—it is envisaged—to 300,000 bpd and save a lot in foreign exchange outgo!
It may be recalled that the petroleum ministry announced recently that they are already working on a revised and comprehensive policy on NELP (New Exploration Licensing Policy). This is awaited with great interest, and it is hoped that they would take the necessary precaution to use the rupee as the base pricing factor rather than the dollar. For the sake of drawing a parallel to international prices, they may use this, but they will fix the parity rate to avoid any dispute later.
Cairn has recently approached the government that their current product sharing contract (PSC), which is valid till 2020, be extended indefinitely, meaning that this should really be allowed to last as long as the economic life of the well. Rightly so! This freedom will enable Cairn, and for that matter all others in similar situation, to plan their investment and expansion policy more realistically. So far, Cairn has invested about $3.8 billion in their fields for development.
Earlier, Cairn had made a representation to the government that the areas they had surrendered in Barmer district be reinstated to them, instead of inviting fresh bids to do so, which is the normal practice. Since no formal advice has been received from the government on this score; a favourable decision would facilitate Cairn's future plans in the area.
In support of their request, Cairn has stated that the economic life of the block is entirely dependent upon the volume produced and the price obtained.
When the revised NELP is announced, it is expected to cover all the contracts—both the old and the new—so that everyone is treated equally.
Due to the shortage and the resultant need to import crude, Indian government does not permit export of oil and gas. In case of Cairn, the oil produced from Barmer, Rajasthan has low sulphur and high wax content, which cannot be easily used by most Indian refineries, because of inherent difficulties in the refinery configuration. As a result, Cairn has recently approached the government that they should be permitted to come to a swap arrangement with Indian Oil Company (IOC) whose refineries are in a position to use low sulphur crude. Such a move, when approved, will benefit Cairn which sells the Rajasthan oil at a discount because of sulphur and wax contents.
As long as the oil producer does not violate the law of the land, they should not be subject to such approvals from government for selling their products to another domestic company, which, in this case, happens to be a government entity. This move will also benefit IOC in the long run. It appears that an earlier request to have this processed in Jamnagar refinery (owned by Reliance) was not approved. Such obstacles are handicaps in national development and need to be avoided.
A brief study of their website indicates satisfactory progress made in their operations in Rajasthan, Andhra Pradesh and Gujarat. Cambay basin (in Gujarat) is the smallest unit with a production of 5,204 barrels of crude oil and 18 mmscf (million standard cubic feet) of gas per day. As against this, Rawa (off Andhra Pradesh) has a daily crude output of 27,165 barrels and gas at 55 mmscf per day. Rajasthan's Barmer leads in oil production at 180,000 barrels per day.
Once some of these pending matters are cleared, it would appear that Cairn has its own plans for making future financial commitments and to undertake new projects.
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)