Glaxo: The foundation is set

Performance summary

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MNC pharma major, GSK Pharma, declared its 2QCY04 and 1HCY04 results. Net sales were up 3.8% in 2QCY04 while for the first half of the current year, sales grew by 10.4%. However, in spite of margin expansion at the operational level, net profit fell due to higher extraordinary income effect.

(Rs m)	2QCY03	2QCY04	Change	1HCY03	1HCY04	Change
Net sales	2,999	3,113	3.8%	5,609	6,191	10.4%
Other income	172	162	-6.0%	269	298	10.8%
Expenditure	2,289	2,330	1.8%	4,401	4,627	5.1%
Operating profit (EBDITA)	710	783	10.4%	1,207	1,565	29.6%
Operating profit margin (%)	23.7%	25.2%		21.5%	25.3%
Interest	-	1		0	-
Depreciation	44	40	-9.1%	88	80	-8.8%
Exceptional Item	123	(2)		123	(61)
Profit before tax	838	905	8.0%	1,512	1,722	13.9%
Tax	313	312	-0.4%	513	629	22.6%
Profit after tax/(loss)	648	591	-8.8%	998	1,093	9.5%
Net profit margin (%)	21.6%	19.0%		17.8%	17.7%
No. of shares (m)	74.7	74.7		74.7	74.7
Diluted earnings per share (Rs)*				26.7	29.3
P/E ratio (x)					20.4
(*annualised)

What's the company's business?

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GSK India is the largest pharma company in the Indian market with a share of 6.3%. It is a 49% subsidiary of US$ 37 bn Glaxo group - the world's second largest pharma company with a R&D war chest of US$ 4 bn. GSK India's product portfolio boasts of some of the leading brands like Zinetac, Betnesol, Cobadex Forte and Zevit in the domestic pharma market. Most of the company's products face stiff price competition from domestic players and growth in the company has been a key area of concern off late. The company underwent a restructuring exercise and effect of the same was evident in 2003 results. It derives its revenues from two segments viz. pharmaceuticals and others (animal healthcare).

What has driven performance in 2QCY04?

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Animal healthcare cast shadow on overall sales: The pharmaceutical segment grew by 5.6% led by strong growth in power brands and is in line with the market growth. However, the company is also marred by the NPPA cover (where pricing restrictions are in place). Since drugs under the NPPA cover accounts for 33% of revenues, the ability to increase prices are limited and therefore, acts as a hindrance. The company is putting in efforts to reduce the contribution. However, total revenue growth was impacted by the decline the animal health care business (down 1.5% YoY in 2QCY04). This business segment accounts for about 17% of revenues. However, going forward, we expect growth to accelerate from new product launches towards the end of the calendar year in CVS, CNS and diabetology segments.

Cost break-up

Cost Structure	1HCY03	1HCY04	Change	% sales 1HCY03	% sales 1HCY04
Raw Material	2,679	2,881	7.5%	48%	47%
Staff Cost	676	701	3.6%	12%	11%
Others	1,046	1,045	-0.1%	19%	17%
Total	4,401	4,627	5.1%	78.48%	74.73%

Impressive margin expansion: There was a 150 basis-point (1.5%) expansion in operating margins, mainly on account of higher contribution from power brands. The gross margin has expanded also due to lower marketing, sales promotion and administrative expenses. However, at the net profit level, profit margin declined by 260 basis points. However, this should be viewed in the context of extraordinary income in the same quarter last year. If one excludes the effect of extraordinary income, net margins have increased by 150 basis points or 1.5%.

What to expect?

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The stock is trading at Rs 597 implying a P/E multiple of 20.4 times annualized 1HCY04 earnings. The earnings in 1HCY04 were better than our expectations. The property sale income of Rs 1 bn will add to the bottomline in the forthcoming quarter and will increase the EPS by Rs 11.5 (post tax). The effect of restructuring is reflected in the last few quarters and the impending transition into the patent regime will result in the company launching new products from the parent's portfolio. Going forward, the company is also likely to start clinical trials, which shows that the Indian subsidiary of Glaxo worldwide is on the high radar.