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GSK Pharma: The high base effect! - Views on News from Equitymaster

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GSK Pharma: The high base effect!
Jul 26, 2006

Performance summary
GSK Pharma has announced mixed results for the second quarter and half year ended June 2006 (January to December fiscal). Both the topline and bottomline have declined during the quarter due to the high base effect of 2QCY05, which had seen exceptionally high sales due to re-stocking by retailers post the implementation of VAT from April 1, 2005. For the half year, however, the picture is much better with both the topline and bottomline logging in good growth rates.

Financial performance: A snapshot
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Net sales 4,650 4,073 -12.4% 7,412 8,335 12.5%
Expenditure 3,077 2,822 -8.3% 5,130 5,672 10.6%
Operating profit (EBDITA) 1,573 1,252 -20.4% 2,282 2,663 16.7%
EBDITA margin (%) 33.8% 30.7%   30.8% 31.9%  
Other income 140 183 31.2% 277 405 46.2%
Depreciation 38 39 3.4% 75 77 2.7%
Profit before tax 1,675 1,396 -16.6% 2,484 2,991 20.4%
Exceptional item (19) -   (98) (22)  
Tax 621 485 -21.8% 883 1,047 18.6%
Profit after tax/(loss) 1,035 911 -12.0% 1,503 1,922 27.9%
Net profit margin (%) 22.3% 22.4%   20.3% 23.1%  
No. of shares (m) 84.7 84.7   84.7 84.7  
Diluted earnings per share (Rs)*         64.2  
Price to earnings ratio (x)*         15.8  
(* 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%. 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 2QCY06?
Slowdown in revenue growth: Revenues for the quarter declined by 12% YoY due to the high base effect of 2QCY05. It must be noted that the company reported very high sales in 2QCY05, which was on the back of re-stocking by retailers post the implementation of VAT from April, 2005. Thus, the topline growth for 1HCY06 gives a much truer overall picture. The 12% YoY revenue growth in 1HCY06 can be attributed to a strong performance by its 30 power brands in the pharma division (85% of total sales) 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 Virbac Animal Health India Pvt Ltd for a total consideration of Rs 2 bn. The sale is in the process of being completed.

Shrinkage in margins: Margins contracted by 310 basis points during the quarter despite the decline in raw material costs as a percentage of sales. This was due to an increase in staff costs and other expenditure. For the half -year however, margins improved 110 basis points backed by a better product mix and a fall in raw material costs. Going forward, any improvement in margins will come from a growth in the topline, as there is not much upside from further cost reduction.

Cost break-up
(% of sales) 2QCY05 2QCY06 1HCY05 1HCY06
Raw material consumption 44.2% 41.7% 43.5% 41.8%
Staff cost 8.8% 10.5% 10.3% 9.6%
Other expenses 13.1% 17.0% 15.4% 16.7%

Reflected in the bottomline: Bottomline also fell by 12% YoY during the quarter in line with the decline in revenues. Even a 31% YoY increase in other income and a lower tax outgo could not stem the decline in bottomline.

Over the last few quarters: If one excludes the impact of VAT, GSK Pharma’s growth at the topline level has been consistent. What has been commendable is that the company on an average has maintained margins at around 30% levels, which is the highest amongst the MNC pharma companies under our coverage.

Quarterly trend
(%) 1QCY05 2QCY05 3QCY05 4QCY05 1QCY06 2QCY06
Net sales growth -23.1% 29.1% 12.6% 14.5% 54.3% -12.4%
Operating profit margin 25.7% 33.8% 31.6% 20.5% 33.1% 30.7%
Net profit growth -26.7% 42.0% 79.3% 79.3% 115.8% -12.0%

What to expect?
At the current price of Rs 1,017, the stock is trading at a price to earnings multiple of 15.8 times its trailing twelve months earnings. Glaxo’s focus on its power brands is expected to contribute to revenues going forward. The company is looking to launch new products into the country through the in-licensing route and has also unveiled plans to launch patented products in India from its parent’s product folio. These products include ‘Lapatinib’ (anti-cancer) and two vaccines, which will be launched CY07 onwards. 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. We shall soon update our research report on the company.

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