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GSK Pharma: Stellar start!

May 2, 2006

Performance summary
GSK Pharma has announced strong results for the first quarter ended March 2006 (January to December fiscal). For the quarter, the topline has grown by 54% YoY. The bottomline growth has, however, outperformed this growth in topline, backed by significant margin expansion and a rise in other income.

Financial performance: A snapshot
(Rs m) 1QCY05 1QCY06 Change
Net sales 2,762 4,262 54.3%
Expenditure 2,053 2,851 38.9%
Operating profit (EBDITA) 710 1,411 98.8%
EBDITA margin (%) 25.7% 33.1%
Other income 137 222 62.1%
Depreciation 37 38 1.1%
Profit before tax 810 1,596 97.1%
Exceptional item (78) (22) -71.9%
Tax 262 561 114.3%
Profit after tax/(loss) 469 1,012 115.8%
Net profit margin (%) 17.0% 23.8%
No. of shares (m) 87.3 84.7
Diluted earnings per share (Rs)* 65.7
Price to earnings ratio (x)* 21.0
(* on a trailing 12-month basis)

What is the company's business?
Glaxo is the largest pharma company in the Indian market with a share of 6.5% (December 2004). It is a 49% subsidiary of the US$ 33 bn Glaxo Group, the world's second-largest pharma company with an R&D war chest of US$ 4 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, animal healthcare and fine chemicals. In 2004, it successfully merged Burroughs Wellcome India with itself.

What has driven performance in 1QCY06?
Outpacing its peers: GSK Pharma clocked an impressive 54% YoY growth in topline in 1QCY06 propelled by its key pharmaceuticals business (85% of total sales) and outpacing its peers Pfizer and Aventis. However, investors should note that the topline performance should be viewed in context of VAT related issues, which had plagued the company and had led to a 23% YoY decline in revenues in 1QCY05. Besides this, the growth in revenues can also be attributed to a strong performance by its 30 power brands and contribution from new products launched last year.

As regards other businesses (animal healthcare and fine chemicals), we will not be able to comment on the performance of the same since the details are unavailable. That said, the management has approved the proposal for sale of its animal healthcare business in India (Agrivet Farm Care) to a leading European company for a total consideration of Rs 2 bn. This is subject to the receipt of the requisite approvals.

Sharp margin expansion: Tight wield over costs and an improved product mix contributed to the steep margin improvement by 740 basis points during the quarter. The company saw a decline in all its costs (as a percentage of sales) as can be seen in the table below.

Cost break-up
(% of sales) 1QCY05 1QCY06
Raw material consumption 42.2% 41.9%
Staff cost 12.9% 8.7%
Other expenses 19.2% 16.3%

Bottomline bloats: Bottomline recorded a superlative 116% YoY during the quarter backed by a robust growth in revenues and improvement in operating margins. A rise in other income has also played a part in contributing to the growth in bottomline despite a considerably higher tax outgo.

Over the last few quarters: Glaxo's performance at the topline and bottomline level has been consistent, with the exception of the blip in 1QCY05, wherein overall performance was affected due to de-stocking by trade in anticipation of the introduction of VAT. The company's efficiencies at the operating level can be gauged by the fact that on an average it has consistently maintained margins above 25%.

Quarterly trend
(%) 4QCY04 1QCY05 2QCY05 3QCY05 4QCY05 1QCY06
Net sales growth 23.5% -23.1% 29.1% 12.6% 14.5% 54.3%
Operating profit margin 23.1% 25.7% 33.8% 31.6% 20.5% 33.1%
Net profit growth 61.4% -26.7% 42.0% 79.3% 79.3% 115.8%

What to expect?
At the current price of Rs 1,425, the stock is trading at a price to earnings multiple of 29.5 times our estimated CY07 earnings. Glaxo has been focusing on its power brands and these are expected to contribute to revenues going forward. The company will soon be entering growing market segments like cardiovascular, CNS and diabetes. It is also exploring in-licensing opportunities in the gynaecology, gastroenterology and nutritional segments. The company is planning to increase activities on the clinical trials front, which shows that the Indian subsidiary is high on the parent's radar. As far as product launches are concerned, Glaxo is planning to launch four products in the domestic markets in CY06. We shall soon update our research report on the company.

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