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GSK Pharma: At the top! - Views on News from Equitymaster
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GSK Pharma: At the top!
Aug 10, 2005

Performance summary
GSK Pharma (Glaxo) had recently announced its results for the second quarter and half year ended June 2005. While the topline grew at a healthy pace outpacing its MNC peers in the pharmaceutical industry, continuous efficiencies at the operating level led to a sharp expansion in operating margins and consequently a strong bottomline growth.

Financial performance: A snapshot
(Rs m) 2QCY04 2QCY05 Change 1HCY04 1HCY05 Change
Net sales 3,603 4,650 29.1% 7,197 7,412 3.0%
Expenditure 2,568 3,077 19.8% 5,150 5,130 -0.4%
Operating profit (EBDITA) 1,035 1,573 52.0% 2,047 2,282 11.5%
EBDITA margin (%) 28.7% 33.8%   28.4% 30.8%  
Other income 123 139 13.0% 247 277 12.1%
Depreciation 41 38 -7.3% 82 75 -8.5%
Profit before tax 1,117 1,674 49.9% 2,212 2,484 12.3%
Exceptional item (2) (19) 850.0% (61) (98) 60.7%
Tax 387 621 60.5% 782 883 12.9%
Profit after tax/(loss) 728 1,034 42.0% 1,369 1,503 9.8%
Net profit margin (%) 20.2% 22.2%   19.0% 20.3%  
No. of shares (m) 87.3 84.7   87.3 84.7  
Diluted earnings per share (Rs)*       32.3 35.5  
Price to earnings ratio (x)         24.7  
(* annualised)            

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 US$ 37 bn Glaxo Group, the world's second largest pharma company with a R&D war chest of US$ 4 bn. Glaxo's product portfolio boasts of some of the leading brands like Augmentin, Zinetac, Betnesol, Cobadex Forte 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 2QCY05?
Outpacing peers:  After a 23% YoY decline in revenues in 1QCY05, Glaxo recovered and clocked an impressive 29% YoY growth in revenues, clearly ahead of its peers in the industry like Pfizer, Aventis and Novartis. This healthy growth could be attributed to the strong performance of the pharmaceutical division, which accounts for 84% of the total revenues. The company’s strategy of focusing on its power brands has also contributed to this growth. The other businesses include the fine chemicals and animal health businesses. However, due to unavailability of data on these segments, we are not in a position to comment on the same.

The spectre of the first quarter’s poor performance pressurized the first half of the company, as it recorded a marginal 3% YoY growth in topline. Investors should note that VAT related concerns had dented the topline picture in 1QCY05.

Steep margin expansion:  Glaxo’s continuous efforts to exert a tight control over the costs are reaping rich benefits. As can be seen from the table below, raw material, staff cost and other expenditure (all as a percentage of sales) have witnessed a reduction in both the quarter and the half-year. This has led to a sharp 510 basis points improvement in the operating margins.

Cost break-up
(% of sales) 2QCY04 2QCY05 1HCY04 1HCY05
Raw material consumption 44.2% 44.2% 44.8% 43.5%
Staff cost 11.2% 8.8% 10.5% 10.3%
Others 16.4% 13.7% 16.7% 16.0%

It flows to the bottomline:  Backed by a strong revenue growth and margin improvement at the operating level, bottomline grew by 42% YoY during 2QCY05. Extraordinary expenses during the quarter included a claim related to formulations pricing and costs associated with buyback of shares. For the half year, extraordinary items included costs of separation and retirement benefits of the management staff at the Bangalore factory.

Over the last few quarters:  Glaxo has been able to maintain operating margins above 25% level on a sustained business over the past few quarters. What is also commendable is the fact that despite a drop in revenues in 1QCY05, the company still managed to maintain its margins during the said quarter.

Quarterly trend
(%) 1QCY04 2QCY04 3QCY04 4QCY04 1QCY05 2QCY05
Net sales growth 20.6% 3.8% 20.0% 23.5% -23.1% 29.1%
Operating profit margin 24.2% 25.2% 31.6% 23.1% 25.7% 33.8%
Net profit growth 43.0% -8.8% 201.2% 61.4% -26.7% 42.0%

What to expect?
At the current price of Rs 875, the stock is trading at a price to earnings multiple of 24.7 times its annualised 1HCY05 earnings, which is at the higher end of the valuation spectrum. Glaxo has focused itself on its power brands and is likely to dominate these categories going forward. Glaxo will soon be entering growing market segments like cardiovascular, CNS and diabetes. It is exploring in-licensing opportunities in the gynaecology, gastroenterology and nutritional segments. Going forward, the company is also likely to start clinical trials, which shows that the Indian subsidiary is high on the parent’s radar. Also, now that the product patent regime has come into force in India, the company is set to launch newly patented products from its parent’s portfolio (after 2007). However, though beneficial in the long term, the impact of the product patent regime is not likely to have an immediate impact on growth. Having said that, prospects for the company look good from a long-term perspective.

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