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GSK Pharma: Fit and fine! - Views on News from Equitymaster
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GSK Pharma: Fit and fine!
Oct 28, 2005

Performance Summary
GSK Pharma announced its results for the third quarter and nine months ending September 2005. While the topline grew at a slower pace as compared to the second quarter (29% YoY growth), performance at the operating level in terms of margins has remained stable. Bottomline however, has surged by 79% YoY on account of an extraordinary income. If one were to exclude this income, bottomline has registered a 20% YoY growth.

Financial performance: A snapshot
(Rs m) 3QCY04 3QCY05 Change 9mCY04 9mCY05 Change
Net sales 3,736 4,207 12.6% 9,972 11,619 16.5%
Expenditure 2,556 2,879 12.6% 7,227 8,009 10.8%
Operating profit (EBDITA) 1,180 1,328 12.5% 2,745 3,610 31.5%
EBDITA margin (%) 31.6% 31.6%   27.5% 31.1%  
Other income 113 178 56.5% 412 454 10.2%
Depreciation 42 38 -8.4% 122 113 -7.4%
Profit before tax 1,252 1,467 17.2% 3,035 3,951 30.2%
Exceptional item 934 2,144 129.5% 873 2,047 134.5%
Tax 461 518 12.3% 1,090 1,401 28.5%
Profit after tax/(loss) 1,725 3,093 79.3% 2,818 4,597 63.1%
Net profit margin (%) 46.2% 73.5%   28.3% 39.6%  
No. of shares (m) 87.3 84.7   87.3 84.7  
Diluted earnings per share (Rs)*       44.4 72.4  
Price to earnings ratio (x)         12.2  
(* 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$ 33 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 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 3QCY05?
Strong topline growth: Topline registered a 13% YoY growth during the quarter, which 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. It must be noted that these businesses contribute around 16% to the company’s topline.

Despite a poor performance in the first quarter on account of VAT related concerns, the company staged a strong recovery in the second as well as third quarter resulting in a decent 17% YoY growth in the first nine months of the year.

Stable margins: Margins remained stable at 32%, the same as the corresponding previous quarter. As can be seen from the table below, while the company has managed to wield control over staff costs and other expenditure, raw material costs as a percentage of sales has witnessed a rise by 190 basis points. In fact, this has been the case with some of the major MNC pharma companies as well.

If we look at the nine months performance, margins have actually improved by an impressive 360 basis points. Glaxo has managed to sustain margins at 31% levels and has outpaced its peers in the year so far, which is commendable. To put things in perspective, Aventis’, Pfizer’s, Novartis’ and Abbott’s margins were at 28%, 20%, 19% and 18% respectively in the first nine months.

Cost break-up
(% of sales) 3QCY04 3QCY05 9mCY04 9mCY05
Raw material consumption 41.0% 42.9% 44.2% 43.3%
Staff cost 10.1% 9.2% 10.8% 9.9%
Others 17.4% 16.3% 17.4% 15.7%

Extraordinary income effect: Glaxo’s bottomline surged by 79% YoY during the quarter. This was due to income received by the company for the sale of its two properties at Mulund. It must be noted that in 3QCY04 too, Glaxo had received a one-time income for the sale of its Worli property. However, if one were to exclude the effect of this extraordinary income, the bottomline growth is at 20% YoY.

Over the last few quarters: Glaxo’s performance at the topline level has been consistent, with the exception of the blip in 1QCY05, wherein sales dipped on the back of VAT related concerns. The company’s efficiencies at the operating level can be gauged by the fact that it has consistently maintained margins above 25%. What is commendable is the fact that margins were maintained even in the first quarter of the year despite a drop in sales.

Quarterly trend
(%) 1QCY04 2QCY04 3QCY04 4QCY04 1QCY05 2QCY05 3QCY05
Net sales growth 20.6% 3.8% 20.0% 23.5% -23.1% 29.1% 12.6%
Operating profit margin 24.2% 25.2% 31.6% 23.1% 25.7% 33.8% 31.6%
Net profit growth 43.0% -8.8% 201.2% 61.4% -26.7% 42.0% 79.3%

What to expect?
At the current price of Rs 880, the stock is trading at a price to earnings multiple of 18.2 times our estimated CY07 earnings. 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. The company is also conducting 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).

We had recommended a ‘Hold’ on the stock in October 2005 with a target price of Rs 1,210. We maintain our view.

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