Downgrade GSK Consumer to 'reduce'

Updated: Feb 20 2013, 09:14am hrs

GlaxoSmithKline PLC has now completed an open offer to acquire an additional stake in its Indian subsidiary, GSK Consumer Healthcare (SKB). The parent companys stake has now increased from 43.16% to 72.46%. The open offer was made at R3,900 per share.

We believe SKB will still deliver ~20% profit growth in the next couple of years. However, at 30.7x CY13F EPS, GSK trades at a significant premium to its three-year average of 25x. We prefer Nestle on a relative basis at similar multiples, which has a more diverse portfolio mix.

Within the food subsector, we prefer Jubilant Foodworks as its long-term potential to drive earnings growth is significantly higher. The catalyst for the shares to drift lower will be on account of SKBs valuations reducing to reflect the long-term earnings growth trajectory.

SKB trades at 25.4x CY14F EPS vs the sector average of ~23.9x FY15F. We believe the valuation has run ahead of the earnings growth potential due to the possibility of a delisting at some point in the future. We prefer Jubilant Foodworks at current valuations (25.8x FY15F) for which the earnings growth over the next couple of years should be significantly higher at ~37%.

After the open offer, GlaxoSmithKlines parent now has the highest stake in its Indian subsidiary across the names in the sector. Unilever has a 52.5% stake in HUVR, Nestle has 62.8% in Nestle India and Colgate has a 51% stake in Colgate Palmolive India.

There remains a possibility that over the next few years, parent companies might look to increase their stakes in these companies.

However, given the regulation that all listed companies should have a minimum 75% shareholding with the non-promoter group, an increase in stakes is more likely for other companies than SKB from current levels, in our view.

Surprisingly, the share price has not corrected. We see two reasons for this. First, given the large number of shareholders who have already tendered their shares, the free float has reduced considerably. Secondly, shareholders who did not tender their shares in the open offer are now holding out for a larger premium to the current share price and a possible delisting of shares in the next few years.

We believe these reasons will continue to support SKBs share price in the near term, but over the next three months or so, we see valuations returning to more normalised levels.