5

International Journal of Marketing, Financial Services & Management Research________________________ ISSN 2277- 3622
Vol.2, No. 5, May (2013)

Online available at www.indianresearchjournals.com
PERFORMANCE ANALYSIS AND SOLVENCY PREDICTION OF

INDIAN PHARMA COMPANIES
PROF. JYOTI NAIR
ASSISTANT PROFESSOR FINANCE
THAKUR INSTITUTE OF MANAGEMENT STUDIES & RESEARCH
KANDIVALI (E), MUMBAI
_____________________________________________________________________________________
ABSTRACT
Globally pharma sector is witnessing huge upheavals due to large number of drugs facing patent
expiration, lack of new drugs, pricing issues. At the same time Indian pharma sector is on a
growth trajectory. The sector is expected to grow to US $ 15 bn by 2015. India is one of the
fastest growing pharma markets in the world with a CAGR of 15% during 2006-11. The
domestic pharma market grew by 13% in the year 2011. The growth is driven by an increase in
urbanization, increase in health care expenditure, rising life expectancy, shift from chronic
diseases to lifestyle diseases and support from Government in the form of liberal policies.
Increase in mergers and acquisition activity has also contributed to the growth in pharma sector.
The pharma sector in India comprise of over 10000 listed and unlisted companies. The objective
of this study is to analyse the performance of pharma companies in India and predict the
solvency of selected companies using Altmans Z score model which is based on Multi variate
Discriminant analysis. The study also purports to identify significant variables affecting the
performance and solvency of the company. Financial indicators like revenues, profits, liquidity,
and capital market performance would be used. The identification of performance and distress
indicators of the companies is expected to provide new insight into company analysis. Financial
ratios are proposed to be used as variables. The results of the study will be validated using
statistical tools of regression
KEYWORDS: Pharma sector, performance analysis, financial distress, z score model, ratios
_____________________________________________________________________________________
Introduction
The Indian pharmaceutical industry is growing at about 8-9% annually. In 2011, the growth was
pegged at 15%. According to McKinsey & Co.s report, Indian Pharma 2020: Propelling access
and acceptance, realizing true potential. Indian pharmacy market will grow to USD 55 billion
by 2020. It also ranks India 3rd in terms of volume among the top 15 drug manufacturing
countries. Patent laws are also expected to boost development of pharma products. Demand for
pharma products in India is also growing due to various factors. Market research firm Cygnus
forecasts that Indian bulk drug industry will grow annually @21%. McKinsey report also
mentions that household spending on health care will grow from 7% to 13% by 2025. All these
factors will contribute to growth of pharma sector in the coming years.
34
Vol.2, No. 5, May (2013)
According to CARE research, demand triggers for the growth are:

1. Patent drugs worth USD170 billion are expected to go off patent leading to huge market
for generic drugs.
2. Exports of pharma products enjoying high margin is expected to grow at a higher rate
than domestic market.
3. Increased M&A activities will consolidate the market leading to development of
specialized segments
4. There are currently approx.175 UDFDA and 90 UK- MHRA approved pharma plants in
India which can supply high quality pharma products globally.
5. Rural demand is expected to surge given the rising income level and awareness.
6. Change in life style has contributed to a shift from chronic diseases to lifestyle diseases.
Government has also taken positive steps to promote this sector by focusing on improvement of
medical infrastructure, rural health care etc. Increased budgetary allocation to National Rural
Health Mission ( NRHM ) is another step in this direction. With 100% FDI being allowed health
and medical services through automatic route, an increased inflow of investment in pharma
sector is visible. Allowing a weighted deduction of 200% for in house research will encourage
research and development of Indian pharma companies.
Pharma sector in India
Indian Pharmaceutical industry is forecasted to have a double digit growth due to increasing
investments in India by Multi -national companies and rising pharma outsourcing to India.
Clinical trial markets if also expected to grow owing to rising R& D in the sector. Bio generics
and pharma packaging are the emerging segments in this sector. Indian companies have
developed an expertise in generic drug segment which will also improve the earning prospects of
pharma companies in India. The major segment in this sector is Pharmaceutical formulations
followed by API /Bulk Drugs and Contract Research and Manufacturing ( CRAMS). Ratings
agency has Fitch has assigned a stable outlook for Indian pharma sector.
The major players in terms of turnover and market capitalisation are Ranbaxy Laboratories,
Cipla Ltd and Dr. Reddys Laboratories. All these companies have registered a growth of 10% 15% during the year 2012 (Emkay research).
At this stage it becomes relevant to study the impact of such upheavals on medium sized
companies in Indian pharma sector. The ability of these companies to sustain their growth in the
wake of major changes in global and domestic market is worth studying and analyzing. The need
to assess the financial health of companies becomes urgent so that remedial steps can be taken to
correct inefficiencies in business. This also becomes very important for managers to take stock
of the situation at an early stage bases on the signals derived from such studies.
35
Vol.2, No. 5, May (2013)
Financial ratios as a tool to predict companys financial distress

Financial distress is end effect of a companys inability to survive in challenging times.
Financially strong company indicates operational efficiency, managerial efficiency, optimum
capital structure and best management practices. Analysis of financial statements using ratios
have been found very useful in prediction financial distress. Ratios like ROA, RONA, Asset
Turnover, Debt equity can help an analyst to assess the performance of the company. Timely
intervention through sound financial strategies can turnaround companies with potential distress.
Objective of the study
1. To study the performance of medium size Indian companies in pharma sector
2. To examine the existence of financial distress among selected Indian companies in
pharma sector using Altmans score model.
Research Methodology
1. 23 companies with a turnover ranging from 500 crs 1000 crs were selected for study.
The data required for the study was obtained from DION database and companys annual
reports.
2. The study is conducted for a period of 5 years from 2008-2012.
3. Altmans z score model is used to identify the existence of financial distress in selected
companies.
4. The data is analysed for significance using step linear regression.
Literature review
Financial ratios have played an important part in evaluating the performance and financial
condition of an entity, (Chen and Shimerda, 1981in Hossari Ghassan and Shaikh Rehman, 2005).
A major function of financial statement analysis is to assess the risk of financial distress. The use
of financial data to predict corporate failure has been a topic of much research interest in
accounting and finance since mid 60s, (Poston et al, 1994). Researchers have used various ratios
from time to time. Hector (2004) discusses the development of these tools. According to him, the
earliest study using financial ratios was undertaken by Alexander Wall and published in 1919.
Walls index consisted of seven ratios viz : Current ratio, net worth to total debt, net worth to
fixed assets, sales to receivables, sales to inventories, sales to fixed assets, sales to net worth,
(Aziz, 1984). Subsequent studies to differentiate bankrupt companies from non bankrupt
companies have been attributed to various researchers for instance Ramser and Foster (1931),
Fistzpatrick (1932), Foulke (1933) and Winakar and Smith (1935) in Hector, 2004. Later Beaver
(1966) in Hector 2004 analysed different financial ratios in a univariate model. Altman (1968)
improved on Beavers univariate model by using Multiple Discriminant Analysis (MDA). He
developed a five variant discriminant model out of 22 potentially predictive ratios as Working
capital /Total Assets, Retained earnings / Total Assets, EBIT / Total Assets, Market value of
equity / Total Assets, Sales / Total Assets. According to him companies went bankrupt if Z score
36
Vol.2, No. 5, May (2013)
was less than 1.81 which means they are not statistically significant at 20% level approximately.
Z score model was found to be helpful in predicting failure in publicly listed companies, (Wang
and Campbell, 2010). Altmans Z score was found useful in evaluation financial distress of
Indian IT companies, Arun and Kasilingam (2011).
Subsequent research also includes investigations of the characteristics of failing firms in special
sectors: Altman (1973) on the railroad industry; Edmister and Schlarbaum (1974), Sinkey (1975,
1977); Martin (1977); Santomero and Vinso (1977); Pettway and Sinkey (1980) on the banking
industry, Altman (1977a) on savings and loan institutions, Altman and Loris (1976) on the over
the-counter broker-dealer industry; Edmister (1972) on small-business failures, Schipper(1977)
and Shrieves and Stevens (1979) on the educational entities; Pinches andTrieschmann (1974) on
the insurance industry (all in Salehi and Abedini, 2009) , Chen and Lee ( 1993) on oil industry
and Joseph et al ( 2008) on health systems.
Moyer ( pre -1986) have found that multivariate models can provide useful insights but other
factors such as firm age, macro economic considerations , impact of risk would have to be
incorporated in future analysis
Most of the studies done have focused on developed markets. There is a need to assess the
financial strength of companies in developing economies.
Data collection and analysis
Altmans Z- score model is used to identify the financial distress in selected companies.
The following model proposed by Altman ( 1968 ) for manufacturing companies is used for the
study :
Z = 1.2 X1+1.4X2+3.3X3+0.6X4+1X5
Where
X1 = Working capital to Total assets
X2= Retained earnings to Total assets
X3= Earnings before interest and taxes to Total assets
X4 = Market value of equity to Total liabilities
X5= Sales to Total assets
Significance of the variables
Eidleman (1995) defines each of the above ratios as follows:
37
Vol.2, No. 5, May (2013)
X1 is a liquidity ratio , the purpose of which is to measure the liquidity of the assets in relation
to firms size .It is the measure of net liquid asset of a concern to the total capitalization which
measures the firms ability to meet its maturing short-term obligations.
X2 is an indicator of the cumulative profitability of the firm over time which indicates the
efficiency of the management in manufacturing, sales, administration and other activities.
X3 is a measure of firms productivity which is crucial for the long-term survival of the
company. It is a measure of productivity of an asset employed in an enterprise. The ultimate
existence of an enterprise is based on earning power. It measures how effectively a firm is using
its resources. It measures the managements overall effectiveness as shown by the returns
generated on sales and investment.
X4 defines how the market views the company. The assumption is that with information being
transmitted to the market on a constant basis, the market is able to determine the worth of the
company. This is then compared to firms debt. It is reciprocal of familiar debt equity ratio.
Equity is measured by the combined market value of all shares, while debt includes both current
and long term liabilities. This measure shows how much of an asset can decline in values before
liabilities exceed the assets and the concerns become insolvent. It measures the extent to which
the firm has been financed by debt. Creditors look to the equity to provide the margin of safety,
but by raising fund through debt, owners gain the benefit of marinating
control of the firm with limited investment.
X5 is defined as a measure of management ability to compete. The capital turnover ratio is the
standard financial measure for illustrating the sales generating capacity of the assets.
The zones are identified as under:
Z < 1.81
Distress zone
Z between 1.81 2.99 Grey zone
Z > 2.99
Safe zone
Altman has described that firms with scores between 1.81 to 2.99 should be thought of as a grey
area. Firms, with Z scores within this range, are considered uncertain about credit risk and
considered marginal cases to be watched with attention. Altman (1968) formerly described the
grey area as the zone of ignorance. This area is where firms share distress and non-distress
financial characteristics and should be carefully observed before it is too late for any remedial or
recovery action. Firms with Z scores below 1.81 indicate failed firm, Z score above 2.99
indicates non-bankruptcy. Altman shows that bankrupt firms have very peculiar financial profiles
one year before bankruptcy (Ray, 2011)
23 companies in Pharma sector with a turnover within a range of 500 crs to 1000 crs were
selected for study. The independent variables (ratios) in the discriminant function were
38
Vol.2, No. 5, May (2013)
determined for the period 2008-2012. Table 1 gives the turnover and values of X1-X5 of the
selected companies and their Z score for 2012.
Table1
SN Name of the company
1
2
3
4
Elder Pharmaceuticals Ltd

Parabolic Drugs Ltd
Ind Swift Ltd
Novartis India Ltd
5
6
7
8
9
10
11
12
13
14
Ankur Drugs and Parma Ltd

Unichem Laboratories Ltd
Shasun Pharmaceuticals Ltd
Strides Arcolab Ltd
Panacea Biotec Ltd
FDC Ltd
Hikal Ltd
Aarti Drugs Ltd
Twilight Litaka Parma Ltd
Claris Life Sciences Ltd
JB Chemicals and Pharmaceuticals
Ltd
Sharon Biomedicine Ltd
Ajanta Parma Ltd
Wyeth Ltd
Merck Ltd
Indoco Remedies Ltd
Granules India Ltd
Astra Zeneca Parma India Ltd
Fresenius Kabi Oncology Ltd.
15
16
17
18
19
20
21
22
23
Turnover
Rs. Crs
984.69
924.34
876.47
843.61
X2
0.15
0.04
0.13
0.26
X3
0.12
0.10
0.09
0.13
X4
0.67
0.20
0.09
2.18
X5
0.57
0.70
0.71
0.47
Z
2.10
3.09
3.09
3.09
824.00
803.19
735.91
728.50
700.58
699.24
694.24
665.36
657.34
650.95
X1
0.44
0.44
0.40
0.45
0.04
0.17
0.32
0.50
0.14
0.06
0.19
0.27
0.65
0.25
0.04
0.48
0.16
0.06
0.10
0.44
0.18
0.22
0.24
0.27
0.04
0.11
0.06
0.05
-0.09
0.20
0.13
0.09
0.20
0.10
0.02
5.97
1.95
2.61
0.72
1.72
1.03
0.44
0.09
1.98
0.48
0.78
1.01
0.22
0.38
0.82
0.61
1.09
1.39
0.41
0.63
5.59
3.01
2.62
0.83
3.21
2.13
2.28
3.24
2.58
642.41
606.05
604.27
588.67
576.31
564.31
563.07
530.89
524.32
0.34
0.56
0.29
0.70
0.62
0.24
0.19
0.27
0.29
0.41
0.15
0.11
0.54
0.10
0.24
0.20
0.39
0.31
0.07
0.11
0.17
0.32
0.16
0.10
0.11
0.08
0.04
0.56
0.99
1.42
12.72
11.21
0.32
0.44
27.33
3.45
0.55
1.03
0.98
0.90
1.14
0.86
1.11
1.55
0.52
2.08
2.88
2.87
11.19
9.29
1.94
2.85
19.09
3.52
Analysis
Total
no
companies
23
100%
of Safe zone
11
48%
Grey zone
Financially distressed
10
43%
02
9%
39
Vol.2, No. 5, May (2013)
As seen above, 48% of the companies selected are in the grey zone and 9% of the sample
selected is financially distressed. 10 companies out of 23 companies have been identified as
potential cases of financial distress. Z- score of the companies in the grey zone for the years 2008
2012 is given in Table 2
Table 2
SN
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Name of the company

Elder Pharmaceuticals Ltd
Parabolic Drugs Ltd
Ind Swift Ltd
Novartis India Ltd
Ankur Drugs and Parma Ltd
Unichem Laboratories Ltd
Shasun Pharmaceuticals Ltd
Strides Arcolab Ltd
Panacea Biotec Ltd
FDC Ltd
Hikal Ltd
Aarti Drugs Ltd
Twilight Litaka Parma Ltd
Claris Life Sciences Ltd
JB Chemicals and Pharmaceuticals Ltd
Sharon Biomedicine Ltd
Ajanta Parma Ltd
Wyeth Ltd
Merck Ltd
Indoco Remedies Ltd
Granules India Ltd
Astra Zeneca Parma India Ltd
Fresenius Kabi Oncology Ltd.
2012
2.1
3.09
3.09
3.09
0.63
5.59
3.01
2.62
0.83
3.21
2.13
2.28
3.24
2.58
2.08
2.88
2.87
11.19
9.29
1.94
2.85
19.09
3.52
2011
2.23
1.74
1.71
10.03
1.51
4.88
2.11
1.8
2.08
3.53
1.73
2.08
3.03
1.97
2.59
2.6
2.68
14.24
9.82
3.27
2.34
18.33
2.99
2010
2.28
2.06
1.85
10.53
1.74
4.73
2.69
1.31
2.08
4.14
2.21
2.76
3.42
2.17
2.95
2.58
2.21
11.33
9.36
3.94
2.53
25.47
4.29
2009
2.24
1.8
1.83
9.94
1.81
6.12
2.09
1.07
1.65
3.64
2.13
2.31
3.53
NA
2.55
2.56
1.9
9.48
7.35
NA
2.03
16.25
3.92
2008
2.79
2.14
1.71
6.91
2.44
4.08
1.78
0.79
2.65
2.76
1.77
1.77
3.52
NA
2.05
2.8
1.99
7.58
6.72
2.41
1.54
11.64
3.11
From the above table it is seen that the z score of the financially distressed companies have been
continuously declining. The main triggers identified are EBIT and Market value of equity.
Regression Analysis
Regression between independent variable X1, X2, X3, X4 and X5 and dependant variable Z was
computed using SPSS. 61% of the companies selected gave results while 39% of the sample
gave indeterminate results. The results are summarized in Table 5
40
Vol.2, No. 5, May (2013)
Table 5
SN
Name of the company
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Elder Pharmaceuticals
Novartis
Unichem Lab
Shasun Parma
Strides Arcolab
Panacea Biotec
Hikal Ltd
Aarti Drugs
Ajanta Parma
Wyeth Ltd
Merck Ltd
Indoco remedies
Granules India Ltd
Astra Zeneca Parma
Significant
Variable
X4
X3, X4
X3,X4
X3,X4
X4
X3,X4
X3
X4
X2
X4,X5
X3,X4
X4
X3
X4
Levels of
significance
0.001
0.001
0.001
0.022
0.001
0.009
0.015
0.002
0.002
0.005
0.000
0.031
0.001
0.001
X3 and X4 are the most dominant variables in determining Z- score. EBIT to Total Assets and
Market value to Total Liabilities are the factors influencing a companys Z- score.
Observations
1. 48 % of the sample companies selected for study is in the Grey Zone and 9% of the
companies are financially distressed. The main factors of financial distress are decreasing EBIT
levels and volatility in market price of the shares. The companies in the grey zone have the
potential of becoming distressed in future if EBIT levels are not improved or maintained.
2. In case of companies with very high Z score (Wyeth Ltd and Astra Zeneca Pharma Ltd),
analysis gives varied results. Wyeth Ltd has shown an increase in operating income and margin
with a very high current ratio. The MPS has also increased consistently thereby making it a very
healthy company. Astra Zeneca Pharma Ltd. has shown reduction in operating income and
operating profits. Its current ratio has also reduced from 2.25 in 2010 to 1.6 in 2012 thereby
indicating that the fundamentals have not improved. However its MPS has shown very high
volatility with closing prices in 2008 of Rs.495 to Rs. 1685 in 2012.
3. In case of companies with very low Z score ( Ankur Drugs & Pharma Ltd and Panacea Biotec
Ltd.) , the results are consistent. Both companies have shown a considerable reduction in
operating incomes and profits. The current ratio has also declined. The MPS of Ankur Drugs and
Pharma have fallen from Rs. 96 in 2010 to Rs.18 in 2012 (closing prices). The MPS of Panacea
Biotec have also shown high volatility.
41
Vol.2, No. 5, May (2013)
4. Novartis Ltds Z score has reduced from 10.03 in 2011 to 3.09 in 2012. Though the company
is in a safe zone, its total liabilities have increased leading to reduction in Working capital to
Total Assets ratio and Market value of equity to Total Liabilities ratio.
5. In case of Parabolic Drugs Ltd. Z score has improved basically due to increased revenues and
EBIT.
6.In the case of Indoco Remedies Ltd., the reduction in Z-score is caused by a heavy decrease in
its share price. The companys Sales and EBIT has shown a consistent growth.
7. Unichem Laboratories Ltd. Consistently high Z score is due to its consistently increasing
Sales.
Other companies with a Z- score above 2 are characterized with:
a) Increase in operating income and profit
b) Current ratio of more than 1.5
c) Net profit margins in the range 7% - 15%
d) Marginal volatility in MPS.
The above observations are validated in Table 5.
Conclusion
Financial ratios can be used to predict potential distress. Application of Z score model could
identify companies with weak fundamentals. EBIT, MPS and Sales are the significant variables
affecting Z score. Study of financial ratios and observing trends will help the management in
evaluating the performance of the company and initiate steps to avoid financial distress and
bankruptcy.
Limitation of the study
The study has focused on 5 financial ratios to identify the financial health of companies.
Research has shown that other variables may be used as a tool to predict financial distress. The
factors affecting the volatility of MPS have not been identified.
Scope for future study
Study can be done to identify other financial ratios and their effectiveness to predict financial
distress. The model can be applied to large cap companies and small cap companies in pharma
sector to evaluate the predictability of the model.
42
Vol.2, No. 5, May (2013)
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International Journal of Marketing, Financial Services & Management Research________________________ ISSN 2277- 3622

Vol.2, No. 5, May (2013)

PERFORMANCE ANALYSIS AND SOLVENCY PREDICTION OF

According to CARE research, demand triggers for the growth are:

Financial ratios as a tool to predict companys financial distress

Elder Pharmaceuticals Ltd

Ankur Drugs and Parma Ltd

Name of the company

Name of the company

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