Over medium term, a revival in Ebitda margin is likely in FY19F
Glaxo trades at 70.1x one-year forward P/E and 10x current EV/sales. The valuations are undoubtedly rich and we believe the stock is factoring in: (i) possible delisting if parent Glaxo Plc buys back the remaining shares. It bought back shares to increase its stake to 75% in Mar 2014 at a valuation of 11.2x EV/sales. (ii) The market expects a strong revival in Ebitda margins. These have declined to 17.3% in FY16 from the peak of 36% in 2009. We believe there are near-term headwinds, as ceiling prices of Glaxo’s largest selling drug, Augmentin, have been brought down by 35%. This will have an adverse impact on FY17F sales of 2%, on our estimates.
Further, Glaxo’s strategy to raise volumes by reducing prices in key products like Synflorix and Seretide is not margin-accretive. We therefore expect Ebitda margins to decline by 23 bps in FY17F. Our FY17F EPS ests are reduced by 47%. The company has failed to acquire assets and grow inorganically, which for us is a disappointment.
Over the medium term, we expect a revival in Ebitda margin to 22% in FY19F. The expansion in margin will be driven by improvement in volumes, new introductions, increased internal production and a tight leash on costs. We use 6.5x EV/sales (in line with the long-term trading average) on Jun 2017F sales of R31.2 billion to arrive at our new target price of R2,483. Our target price implies a PE multiple of 41.2x one year forward (up from 32.5x earlier).
Given suppressed earnings, we believe an EV/sales metric is better suited to capture the long-term revival in margins and hence our TP cut.
Weak financial performance on the back of impact of price control: Our FY17F/18F EPS ests are 23%/17% lower than consensus. Valuation: The stock trades at 70.1x one-year forward EPS compared with a six-year average of 45.8x.
Vaccines: Key growth driver going forward
Glaxo commands a dominant position in the domestic vaccines market. Glaxo’s position in the vaccine market is bolstered by its acquisition of the Novartis’s vaccines portfolio. In Sep 2015, Glaxo completed the acquisition of Novartis’s vaccines portfolio in India. GSK agreed to acquire Novartis’ vaccine portfolio along with its manufacturing assets and GSK would transfer the oncology portfolio to Novartis. Novartis’s vaccines portfolio contributed sales of R610 million in 2H16, as per management. The anti-rabies vaccine, Rabipur, contributed greater than Rs 500 million in 2H16 and was the most significant contributor from the acquired portfolio, in our view. Glaxo’s Vaccines business accounted for 18% of its overall sales in FY16. We expect the contribution from Vaccines to increase beyond 20%. Glaxo has three vaccines, with sales close to Rs 1 billion annually. Synflorix, Rotarix, and Rabipur (acquired from Novartis) are its top vaccine brands at present.
We expect Glaxo to launch three new paediatric vaccines during FY17-18F. These are Priorix-Tetra, Infanrix-Hexa and Poliorix (inactivated poliomyelitis vaccine). Priorix-Tetra, expected to be launched in FY17F, will be the first of its kind of combination vaccine in India. In FY18F, we believe Glaxo will launch Infanrix-Hexa, a hexavalent paediatric vaccine which also will be the first vaccine of its kind in India. The new vaccines can add Rs 1-1.5 billion in sales by FY19F, in our view. Overall we expect Glaxo to record 23% CAGR over FY16-19F in vaccines. We expect vaccines to contribute almost a quarter of Glaxo’s India sales by FY19F. The growth will be driven by consolidation of the Novartis portfolio, new launches, and organic growth in the base business.