JB Chemicals & Pharma a market performer: PL

Prabhudas Lilladher has downgraded their recommendation on JB Chemicals and Parmeceuticals from outperformer to market performer.

Prabhudas Lilladher Research report on JB Chemicals & Pharma:

Result Snapshot:

J.B. Chemicals & Pharmaceuticals Q4 FY07 results belied expectations, being affected by higher marketing costs, a sharp rise in interest cost and  exchange losses. Though net sales jumped 25% yoy, the operating margin fell 800 bp (from 17.1% to 9.1%) and net profit then plunged 30%. J.B. has substantially invested in expanding its field force, resulting in higher marketing expenses. Moreover, interest cost has risen due to the expansion program. And the strengthening rupee has squeezed profitability.  We have lowered our earlier EPS estimates for FY08 - by 17% (from Rs 11.9 to Rs 9.9). At the CMP of Rs 79, the stock trades at 8x FY08E EPS of Rs 9.9 and 6.4x FY09E EPS of Rs 12.3. In view of company’s poor performance and the strengthening rupee, we are downgrading the scrip from Outperformer to Market Performer. 

Result Highlights:

Strong exports maintain growth momentum:

J.B. Chemicals has reported a 25% jump in net sales -- from Rs 1.14 billion to Rs 1.43 billion - due to strong growth on the export front (we expected Rs 1.5 billion). Domestic sales, though, rose only 17% - from Rs 495 million to Rs 581 million.  Domestic formulations reported a healthy 21% rise - from Rs 455 million to Rs 550 million - due to the commencement of the new division, Auster, which focuses on the CVS and CNS segments. The domestic growth was better than the industry’s 16-17% growth during the quarter. However, sales of API in the home market dropped 23% - from Rs 40 million to Rs 31 million, as the company has reduced its focus on this business.  Exports jumped 32% - from Rs 682 million to Rs 897 million (we expected Rs 968 million), chiefly due to lower export of formulations than our expectation. Exports of formulations too jumped 32% - from Rs 645 million to Rs 854 million - from healthy exports to Russia and the CIS countries. JB markets two major products, Doktor Mom (cough syrup) and Rinza (anti-cold preparation), which are in demand in the CIS markets. API exports grew a moderate 16% - from Rs 37 million to Rs 43 million. Since 57% of the company’s revenue arose from exports in FY07, to a large extent it is exposed to currency fluctuations.  Overall, net sales were 5% lower than we expected. 

Sharp decline in margins due to high ‘other expenses’:

 JB’s operating margin fell 800 bp - from 17.1% to 9.1% (we expected 18.7%) due to the sharp rise in ‘other  expenses’. Cost of material rose 180 bp - from 31.1% to 32.9% of net sales - due to the change in product mix,  with greater domestic sales. Personnel expenses increased 60 bp - from 13.8% to 14.4% of net sales. ‘Other expenses’ went up a sharp 560 bp - from 38% to 43.6% of net sales. 

Rise in marketing expenses: 

Marketing expenses sharply rose due to the commencement of the new division, Auster, which focuses on the CVS and CNS segments and due to the increase in the field force in Russia and the CIS countries. Marketing expenses climbed Rs 45 million in the quarter and Rs 90 million for the year. This has resulted in a sharp fall in the operating margin. 

Project implementation leads to higher interest cost:

In March ’07, JB implemented the new small-volume parenterals (SVP) and large-volume parenterals (LVP) project at Panoli, for which it incurred Rs 794 million. Its short-term borrowing for this resulted in higher interest cost, which shot up 79% during the quarter - from Rs 19 million to Rs 34 million. 

Strengthening its position in S. Africa through an acquisition: 

The company has strengthened its position in S. Africa by acquiring a 49% stake in Biotech Labs, S. Africa, for USD 5.1million (Rs 215 million). The latter’s Blacks-empowerment status allows it to participate in African government tenders. JB also plans to market its products in S. Africa using Biotech’s distribution network. The acquisition was done through internal accruals. 

The strengthening rupee a worry for pharma exporters:

During the period January to May ’07, the rupee went up by 8% against the dollar. Due to this, JB suffered an exchange loss of Rs 23 million during the quarter and Rs 50 million for FY07. This has naturally affected the quarterly results. 

Amalgamation of subsidiary:

Effective April ’06, its loss-making 100% subsidiary, Lekar Healthcare Pvt. Ltd., has been amalgamated with JB.  During FY07, Lekar reported sales of Rs 100 million and suffered a Rs 25 million loss. This has resulted in a write-back of Rs 35 million in tax in Q4 FY07. 

Financials and Valuations:

FY07 results belie expectations:

The poor performance in Q4 FY07 has affected JB’s results. Its net sales grew merely 14% in FY07 - from Rs  4.65 billion to Rs 5.32 billion (we expected Rs 5.34 billion). The operating margin dropped 160 bp - from 18.8% to 17.2% (we expected 20%). Net profit was marginally up - 1%, from Rs 702 million to Rs 710 million (we expected Rs 813 million). 

Though the FY07 results did not meet our expectations, the new SVP and LVP capacities are expected to contribute from FY08. We estimate revenue of Rs 250 million in FY08 and Rs 500 million in FY09 from these. Moreover, the S. African subsidiary is likely to contribute from FY09. 

Projections:

We expect JB to report a 19% CAGR in net sales in the next two years. We expect the EBIDTA margin to improve - from 19.3% now to 20.8% in FY09 - due to the high-margin injectable products. We expect the net profit to rise at a 21% CAGR in the next two years. 

EPS estimates lowered:

We have lowered our EPS estimates for FY08 by 17% - from Rs 11.9 to Rs 9.9 - due to lower margins, the expected fall in export realizations (due to the strengthening rupee) and the rise in interest costs.  We are downgrading our recommendation for the scrip from Outperformer to Market Performer.