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Neutral rating on GSK Pharma: Profitability disappoints, revenues beat estimates

GSK Pharma’s (GLXO) Q3FY16 sales increased 13% y-o-y to R7.3 bn (9% beat), Ebitda declined 6% to R1.0 bn (19% miss) and PAT was at R799m (up 77% y-o-y, 30% miss). GSK has been struggling with capacity issues for the last few quarters.

By: | Updated: February 15, 2016 2:13 AM

GSK Pharma’s (GLXO) Q3FY16 sales increased 13% y-o-y to R7.3 bn (9% beat), Ebitda declined 6% to R1.0 bn (19% miss) and PAT was at R799m (up 77% y-o-y, 30% miss). GSK has been struggling with capacity issues for the last few quarters.

This is the first quarter since Q4FY15 with double digit top line growth for the company, albeit on a low base. For the last two years, GSK has been facing capacity issues for select brands and has not been successful in finding quality third party suppliers. Profitability has also been hit by severe price cut on key brands like Augmentin. According to AIOCD data, GSK grew 13% y-o-y in December’15 quarter. Most of the growth was driven by top 10 brands which grew 21% y-o-y in Q3. Excluding the top 10 brands, other product portfolio has declined 7-8% y-o-y. Going ahead, we expect revenues to grow at ~13-14% CAGR FY17-18e—in line with industry growth led by (i) commissioning of Bangalore capacity in FY17 (resolving capacity issues), (ii) high volume growth in key brands post new pricing policy, (iii) launches from parent’s pipeline, and (iv) price hikes undertaken in DPCO products.

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Margins disappoint

Ebitda margins at 14.1% (down 300bp y-o-y) were impacted by higher other expenses during this quarter. Gross margin was also lower at 53.1% (down 250bp y-o-y). Ebitda margins have been severely hit by price cut on key brands and higher promotional expenses over last few quarters. This quarter also includes an incremental CSR cost of R110m in other expenses. Going ahead, we expect margin to improve to 22-24% over FY16-18e, driven by higher revenues and price hike in key brands.

Valuation and view:

We believe GLXO has strong parentage, superior brand portfolio (competitive advantage), high payout ratio (~100%) and industry leading return ratios (RoCE of 50%+). However, the current valuation at 52x FY17e and 41x FY18e is on the higher side of historical PE. Maintain Neutral with target price of R3,130 (@40x on FY18E EPS).

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