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GSK Pharma: The divestment effect! - Views on News from Equitymaster
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GSK Pharma: The divestment effect!
Feb 23, 2007

Performance summary
GSK Pharma (Glaxo) announced results for the fourth quarter and year ended December 2006 (January to December fiscal). Topline growth during the year was staid, largely due to the absence of revenues from the animal health business, which was divested during 3QCY06 and also due to supply shortages from third party manufacturers. An improved product mix led to the expansion in operating margins for both the periods under review. The bottomline grew faster than the topline during the year, backed primarily by higher other income and improvement in operating margins.

Financial performance: A snapshot
(Rs m) 4QCY05 4QCY06 Change CY05 CY06 Change
Net sales 3,234 3,203 -1.0% 14,853 15,529 4.6%
Expenditure 2,572 2,389 -7.1% 10,573 10,770 1.9%
Operating profit (EBDITA) 663 814 22.8% 4,280 4,760 11.2%
EBDITA margin (%) 20.5% 25.4%   28.8% 30.6%  
Other income 210 299 42.8% 656 958 46.0%
Depreciation 44 41 -6.8% 157 159 0.8%
Profit before tax 828 1,072 29.5% 4,779 5,560 16.3%
Exceptional item (89) (4) -95.8% 1,958 1,838 -6.1%
Tax 316 391 23.7% 1,716 1,942 13.2%
Profit after tax/(loss) 424 678 60.0% 5,021 5,455 8.7%
Net profit margin (%) 13.1% 21.2%   33.8% 35.1%  
No. of shares (m) 84.7 84.7   84.7 84.7  
Diluted earnings per share (Rs)*         42.7  
Price to earnings ratio (x)         26.7  
(* on a trailing 12-month basis and excludes the extraordinary item)

What is the company’s business?
Glaxo is the largest pharma company in the Indian market with a share of 6.4% (Source: ORG-IMS Dec 2006). It is a 49% subsidiary of the US$ 39.5 bn Glaxo Group, the world's second-largest pharma company with an R&D war chest of US$ 5.7 bn. Glaxo's product portfolio boasts of some of the leading brands like Augmentin, Zinetac, Betnesol, Cobadex and Zevit in the domestic pharma market. The company underwent a restructuring exercise and effect of the same was evident in 2003 and 2004. It derives its revenues from pharmaceuticals and fine chemicals. In May 2006, the company sold off its animal healthcare business to a European company ‘Virbac’.

What has driven performance in CY06?
Divestment impacts topline: GSK Pharma’s topline during the year grew by a subdued 5% YoY, which was largely due to the divestment of the animal health business in 3QCY06 (5% of total revenues in CY05). The 10% YoY growth recorded by the pharmaceutical division was decent considering the fact that the company faced temporary shortage of product supply from third party manufacturers. Active promotion of priority products (up 15% YoY and accounting for one third of revenues) and shift from the acute to the chronic disease segment has contributed to this revenue growth. However, this growth is still below our estimates for the year and hence we shall have to downgrade our topline estimates accordingly. As far as the animal health business (Agrivet Farm Care), is concerned, the management sold it to Virbac Animal Health India Pvt Ltd for a total consideration of Rs 2 bn.

Segmental snapshot|
(Rs m) 4QCY05 4QCY06 Change CY05 CY06 Change
Pharmaceuticals 2,715 3,068 13.0% 12,864 14,160 10.1%
PBIT margin (%) 23.3% 30.5%   32.4% 34.8%  
% of revenues 80.9% 90.9%   84.8% 88.6%  
Other businesses 640 305 -52.3% 2,307 1,813 -21.4%
PBIT margin (%) 29.5% 27.6%   22.5% 21.2%  
% of revenues 19.1% 9.1%   15.2% 11.4%  
Total revenues 3,356 3,373 0.5% 15,170 15,974 5.3%
PBIT margin (%) 24.5% 30.2%   30.9% 33.2%  

Margins improve: Operating margins expanded by 180 basis points in CY06 owing to an improvement in the product mix (the company has been concentrating on increasing its focus on priority products as these are not under price control) and decline in raw material costs (as percentage of sales). Going forward, we do not forsee a significant rise in operating margins, as there is not much upside from further cost reduction.

Cost break-up
(% of sales) 4QCY05 4QCY06 CY05 CY06
Raw material consumption 43.1% 40.4% 43.2% 41.1%
Staff cost 12.5% 11.0% 10.5% 9.9%
Other expenses 23.9% 23.1% 17.5% 18.3%

The bottomline picture: During the year, bottomline (up 9% YoY) grew faster than the topline, led by the improvement in operating margins and rise in other income. It must be noted that in CY05, GSK Pharma had received extraordinary income on the sale of two of its properties at Mulund. Similarly, the company, during this year, received around Rs 2 bn on the sale of its animal health business. Excluding this impact, bottomline growth has been higher at 18% YoY.

Over the last few quarters: While the topline performance has been volatile, what is commendable is that the company, barring a few quarters, has managed to maintain margins at around 30% levels, which is the highest amongst the MNC pharma companies under our coverage.

Quarterly trend
(%) 3QCY05 4QCY05 1QCY06 2QCY06 3QCY06 4QCY06
Net sales growth 12.6% 14.5% 54.3% -12.4% -5.1% -1.0%
Operating profit margin 31.6% 20.5% 33.1% 30.7% 32.1% 25.4%
Net profit growth 79.3% 79.3% 115.8% -12.0% -7.7% 60.0%

What to expect?
At the current price of Rs 1,141, the stock is trading at a price to earnings multiple of 21.4 times our estimated CY08 earnings. Going forward, GSK Pharma intends to continue its focus on its priority products, which account for a third of its revenues and increase the contribution from the chronic therapy segment. The company has unveiled plans of introducing 3 new products in CY07 and plans to introduce 2 vaccines namely ‘Cervarix’ and ‘Rotarix’ in the domestic market by CY08. GSK Pharma is also planning to increase activities on the clinical trials front, which shows that the Indian subsidiary is high on the parent’s radar. We shall have to downgrade our topline estimates for the year and shall soon update our research report on the company.

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