Merck-Q3CY13 Results Update - Centrum

Margin under pressure
We retain Buy rating on Merck but reduce target price to Rs802 from Rs851 due to
lower than expected Q3CY13 results. Merck’s revenues were in line with our
expectations but EBIDTA margin fell short. The company’s pharma segment grew at
16%, double the industry growth rate of ~8%. However, the chemicals segment
showed marginal revenue decline. We expect the growth rate to improve as one of
its major brands Evion has come out of price control and also vitamin E API. We have
revised our CY13 and CY14 EPS downwards by 8% each. Our target price of Rs802 is
based on 14xSept’15 EPS of Rs57.3, giving an upside of 35.3%

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Good growth of pharma segment: Merck reported 10.4%YoY overall growth in
revenues due to good growth in pharma segment. The company’s pharma segment
(~70% of revenues) grew by 16.3%YoY against the industry growth of ~8%. The
company’s major brand Evion (revenues of ~Rs550mn annually) has come out of price
control. Its chemical segment (30% of revenues) declined marginally by 1%YoY. We
expect the company to maintain growth momentum as its API vitamin E is out of price
control. With no further addition of drugs to price control, we expect the company to
sustain and grow its revenues in future.
Margins under pressure: Merck’s EBIDTA margin declined by 870bps YoY to 10.5% from
19.2% mainly due to overall increase in cost. Its material cost was up by 160bps to 45.5%
from 43.9% due to the rise in cost of imported raw materials with the depreciation of the
rupee. Personnel cost increased by 90bps to 12.6% from 11.7% due to annual increase in
salaries. Other expenses were up by 600bps to 31.3% from 25.3% due to the rise in
transportation cost. The PBIT margin of pharma business fell to 11.8% from 19.9%
whereas that of chemical business dropped to 5.4% from 13.2% indicating lower
profitability of chemical business. We expect the profitability of chemical business to
improve due to higher realisation of exports with the depreciation of rupee.
Decline in net profit: Merck’s net profit declined by 39%YoY to Rs158mn from Rs258mn
due to the lower EBIDTA margin and higher tax rate. Merck is a zero debt and cash-rich
company and earns other income of over Rs50mn per quarter from the treasury. The
company’s tax rate increased to 35.5% from 33.7% due to the revision of tax rates and no
tax shelter for the company.
Valuations and risks: We retain Buy rating on the scrip with a target price of Rs802
based on 14x Sept’15 EPS of Rs57.3 giving an upside of 35.3% over the CMP. We have
revised our EPS estimates downwards by 8% each for CY13 and CY14 in view of lower
than expected results. Key risks include lower demand for the company’s API and
formulations due to market slowdown. The company also faces risk of stiff competition of
its products in the domestic market