No immediate cure for GSK's ailments

Pricing policy continues to impact performance; open offer an opportunity for short-term investors to exit

GlaxoSmithKline (GSK) Pharma’s earnings for the quarter ended December fell short of expectations, as the company grappled with pricing policy, trade-related disturbances and supply constraints. Through the past year, the company has seen its margins fall, owing to muted revenue growth and high costs. While sales were lower than expectations, net profit, boosted by other income, beat analysts’ estimates.

Despite the muted operational performance in the last couple of quarters, the company stock continued to gain, as the Street was expecting announcements on the buy-back and sale-of-land fronts. GSK’s December 16 announcement for a buy-back of shares to increase promoter stake to 75 per cent has led to sharp run-up in stock prices. Despite the unimpressive performance, the stock hit a 52-week high of Rs 3,021 on Tuesday, the first day of the open offer. At close, the stock traded at Rs 3,016.95 on BSE.

The buy-back indicates the parent company’s strong commitment towards its Indian arm. The company had also announced a Rs 864-crore investment to set up a manufacturing facility in India, which will double its capacity. While the full benefits of the new facility, to be commissioned by 2017, will take time to accrue, the impact of the pricing policy is expected to decline gradually. Most pharmaceutical companies are considering a high-volume strategy to overcome the cap on prices.

Given the investment in manufacturing and the impact of pricing will take some time to be overcome, only investors with long investment horizons might retain shares, while others could book profits in this open offer. On fundamentals, the one-year consensus target price for the stock, according to analysts polled by Bloomberg, stands at Rs 2,523, substantially lower than current market price.

Muted quarter
On a standalone basis, at Rs 630.63 crore, GSK Pharma’s December quarter revenue declined four per cent year-on-year; it was slightly lower than the Street’s estimate of Rs 634.6 crore. The company has indicated the trade issue with dealers, which has impacted sales since October, has now been resolved.

On the product pricing front, the company’s major anti-bacterial brand, Augmentin, has come under price control. The product’s sales stood at Rs 264 crore in 2013, a fall of 10.2 per cent, according to IMS data. In January, the brand clocked sales of Rs 21 crore, a decline of 15.9 per cent year-on-year. Of its 10 leading products, seven are reporting falling sales, analysts say. Though the company has launched new products in the dermatology and oncology space, these will take time to see growth. Analysts feel the company will feel the heat for two more quarters, before the low base effect comes into play.

With revenue under pressure, costs such as those on employees and raw material continued to rise. Therefore, the company’s margins slipped from 30 per cent in the year-ago period to 18.7 per cent, resulting in operating profits falling about 40 per cent to Rs 118.3 crore. At Rs 117 crore, Glaxo’s profits are higher than those in the September quarter (Rs 101 crore), though down 15 per cent year-on-year. The Street had estimated a profit of Rs 114 crore. Other income increased 13.4 per cent year-on-year to Rs 47.8 crore. The company also reported an income of Rs 8.4 crore, against a loss of Rs 29.7 crore in the year-ago period.

Open offer
On Tuesday, GSK’s open offer to acquire 20.6 million shares, representing 24.3 per cent of total outstanding shares, got underway. The London-listed parent (GlaxoSmithKline Plc) aims to invest Rs 6,400 crore to acquire the shares at Rs 3,100 apiece. The open offer price was at a 25 per cent premium to the December 13 closing price of Rs 2,468.4. Subsequently, the stock has gained considerably and provides a good exit opportunity to short-term investors.

Sarabjeet Kaur Nangra at Angel Broking says, “Long-term shareholders are advised to remain put in the stock, as in the long run, when new facilities become operational (from 2017), they can easily earn 20 per cent a year on the stock. Investors looking from a near-term perspective should exit the stock, as the valuations at the open offer price are expensive.”