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GSK Pharma: Disappointing quarter - Views on News from Equitymaster

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GSK Pharma: Disappointing quarter
Oct 31, 2006

Performance summary
GSK Pharma (Glaxo) has announced subdued results for the third quarter and nine months ended September 2006 (January to December fiscal). Topline, during the quarter, has declined due to the poor performance of its pharmaceuticals business as well as the absence of revenues from the animal health business, which was divested during the quarter. Operating margins, however, improved largely due to a decline in raw material costs (as percentage of sales). While bottomline has fallen during the quarter, even after excluding the extraordinary items, the growth of the same has been staid.

Financial performance: A snapshot
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9mCY06 Change
Net sales 4,207 3,992 -5.1% 11,619 12,327 6.1%
Expenditure 2,879 2,709 -5.9% 8,003 8,381 4.7%
Operating profit (EBDITA) 1,328 1,283 -3.4% 3,616 3,946 9.1%
EBDITA margin (%) 31.6% 32.1%   31.1% 32.0%  
Other income 178 254 42.9% 448 659 47.1%
Depreciation 38 41 6.5% 113 117 3.7%
Profit before tax 1,467 1,496 2.0% 3,951 4,487 13.6%
Exceptional item 2,144 1,864 -13.1% 2,047 1,842 -10.0%
Tax 518 505 -2.5% 1,401 1,552 10.8%
Profit after tax/(loss) 3,093 2,854 -7.7% 4,597 4,777 3.9%
Net profit margin (%) 73.5% 71.5%   39.6% 38.8%  
No. of shares (m) 84.7 84.7   84.7 84.7  
Diluted earnings per share (Rs)*         61.4  
Price to earnings ratio (x)*         18.6  
(* 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% (Source: ORG-IMS). 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 3QCY06?
Slowdown in revenue growth: Revenues for the quarter declined by 5% YoY largely due to the divestment of the animal health business and poor performance of its pharmaceuticals business. The latter grew by a mere 2% YoY during the quarter owing to a temporary shortage of product supply from third party manufacturers. As far as the animal health business (Agrivet Farm Care), is concerned, the management sold it to Virbac Animal Health India Pvt Ltd for a total consideration of Rs 2 bn and hence this quarter does not reflect revenues from the same. For the nine months ended September 2006, the 6% YoY growth in revenues was largely driven by the 9% YoY growth of its pharmaceuticals business (88% of total revenues).

Segmental snapshot
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9mCY06 Change
Pharmaceuticals 3,608 3,691 2.3% 10,148 11,092 9.3%
PBIT margin (%) 34.7% 35.8%   34.8% 35.9%  
% of revenues 84.0% 90.2%   85.9% 88.0%  
Other businesses 686 401 -41.6% 1,666 1,508 -9.5%
PBIT margin (%) 27.1% 23.8%   19.9% 19.9%  
% of revenues 16.0% 9.8%   14.1% 12.0%  
Total revenues 4,294 4,092 -4.7% 11,814 12,600 6.7%
PBIT margin (%) 33.5% 34.6%   32.7% 34.0%  

Margins improve: Operating margins expanded by 50 and 90 basis points in 3QCY06 and 9mCY06 respectively due to an improvement in product mix and decline in raw material costs (as percentage of sales). Going forward, we do not forsee a significant rise in operating margins, as there is not much upside from further cost reduction.

Cost break-up
(% of sales) 3QCY05 3QCY06 9mCY05 9mCY06
Raw material consumption 42.9% 40.4% 43.2% 41.3%
Staff cost 9.2% 9.6% 9.9% 9.6%
Other expenses 16.3% 17.9% 15.8% 17.0%

Uninspiring bottomline picture: Mirroring the decline in revenues, bottomline also fell by 8% YoY during the quarter. It must be noted that in 3QCY05, GSK Pharma had received extraordinary income on the sale of two of its properties at Mulund. Similarly, the company, during this quarter, received around Rs 2 bn on the sale of its animal health business. However, even after excluding this impact, bottomline growth (up 4% YoY) has been subdued despite a higher other income.

Over the last few quarters: GSK Pharma’s performance at the topline level has been inconsistent in the last few quarters mainly due to the negative impact of VAT and sale of the animal health business. However, what is 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
(%) 2QCY05 3QCY05 4QCY05 1QCY06 2QCY06 3QCY06
Net sales growth 29.1% 12.6% 14.5% 54.3% -12.4% -5.1%
Operating profit margin 33.8% 31.6% 20.5% 33.1% 30.7% 32.1%
Net profit growth 42.0% 79.3% 79.3% 115.8% -12.0% -7.7%

What to expect?
At the current price of Rs 1,143, the stock is trading at a price to earnings multiple of 21.5 times our estimated CY08 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. However, even after factoring in the positives, the stock at current levels seems fairly priced and to that extent we advise investors to exercise caution.

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