The fall in Cipla Ltd’s profitability may be viewed warily by investors, but the company believes this is an outcome of it reinvesting profits to achieve its long-term business goals. That is a justifiable objective. But investors like to have it all and that translates to sustained sales and profitability growth, even in the short run. They might be in for disappointment, unless Cipla pulls out an unexpected rabbit from its hat.
In the March quarter, the pharmaceutical company’s sales rose by just 5.1% to Rs.1,906.2 crore. Its domestic branded generics business actually did quite well, with sales rising by 11% compared with industry growth of 9%. But what pulled down domestic sales growth to 5.2% was a slowdown in its pure generics business, which the company attributed to uncertainty caused by the new drug pricing policy.
The new policy should be a matter of some concern for its entire domestic business. Cipla expects the impact to become clear after the revised drug prices are notified. It is drawing up a plan to counter the impact on its domestic business. Its success or otherwise in this objective will be a key factor to watch for in FY14.
Cipla’s export formulations business revenue rose 11.6% in the March quarter, with some impact on sales visible from the postponement of drug tenders in Africa. Also, its export of APIs (active pharmaceutical ingredients or the key ingredients in a drug) declined by 23.9% due to deferral of orders. That should mean that future quarters could see a bump in sales, when this revenue accrues to it.
Slower sales growth is one cause for the dip in margins since a portion of its costs are fixed. While Cipla’s sales rose 5.1%, material costs actually declined 3.6%. But employee costs rose 40.1% and other expenses rose 8.9%. As a result, operating profit margin declined by 56 basis points to 20.8% and by nearly 3 percentage points sequentially. One reason for higher employee costs is the hiring of talent to meet long-term growth plans. A basis point is 0.01 percentage point.
The company’s employee costs as a percentage of sales have reached 12% in FY13, from 10.7% in FY12. This figure may go up by about half to one percentage point additionally, which it says will bring it on par with industry peers. Cipla also expects its research and development (R&D) expenditure to increase from the current levels of 4%-4.5% of sales by about 1 percentage point.
Cipla expects these investments to improve its front-end presence in key markets, as it shifts from being a focused supplier to generic drug maker to marketing drugs itself. It has already invested significant sums in creating capacity in the past few years. Now its investments are on acquisitions (it is in the process of acquiring South African distributor Cipla Medpro), on the workforce, and on drug filings in developed markets (which result in higher R&D spending).
All of this should contribute to better performance and even see a spike in sales and profits, especially when it has a good pipeline of products. That will happen over a longer period of time. In the meanwhile, its existing business may creak a bit under the burden of having to support its new business strategy. Cipla is clear that this is a sacrifice it is willing to make. Investors have to decide if they want to be part of this journey and the ups and downs that come with it.
Cipla’s net profit declined 8.3% in the March quarter, as the decline in profitability was aggravated by a higher tax incidence. Between early March and mid-May, its share rose 14.9%, but has declined 6% since then. The results may cause it to shed some more value on Thursday since they were announced after market hours on Wednesday.