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Glaxo’s Q1CY08 are marginally ahead of estimates at Rs4.2bn sales and Rs1.2bn profits. Domestic sales growth has continued to be tepid with 5.3% yoy growth. Operating margins at 36.4% are 30bps higher yoy. While Glaxo’s existing portfolio is facing increased competition, the company is striving to take multiple innovative steps like tapping institutional business, increasing penetration in rural areas as also restructuring the sales force to up the
growth momentum. However, these measures have yet to start getting reflected in revenue acceleration.

Further the management remains committed to aggressively introduce newer products from parent’s stable which is very positive. While we agree that Glaxo is clearly the best placed MNCs to leverage from IP era with its large size and rich pipeline of vaccines / patented drugs,we expect the impact of these newer products to start becoming visible only from CY10-11 onwards. In the near term there is limited room for upsides from current levels given the rich valuations and only 12% CAGR in earnings growth over CY07-09. Maintain estimates and reiterate Neutral with a price target of Rs1045 (20xCY08E and 18xCY09E). Glaxo’s ability to accelerate revenue growth through successful new product launches will be key triggers for upgrade.

Net revenues for Q1CY08 were Rs4181m, (0.8%) de-growth yoy. The numbers are not strictly comparable because GSK has divested the Fine chemicals business earlier during the year. Adjusting for that divestment, continuing sales
have grown ~5.3% yoy.

• Domestic pharma net sales have grown at around 6% yoy for the quarter, considerably slower than the market growth rate.

• GSK has indicated that the growth has been impacted by the pipeline inventory adjustments due to the price revisions undertaken during March in the wake of excise duty price changes. The impact of this event not withstanding, we been maintaining that Glaxo has started to face challenges in accelerating the growth on its existing domestic pharma portfolio and the performance over the last few quarters supports that view.

• We have estimated domestic sales to grow at 10% in CY08 and expect GSK to achieve accelerated growth in the subsequent quarters to hit these numbers.

For CY08, Glaxo is targeting the launch of 2 key products – Tykerb and Rotarix. While Tykerb was scheduled to be launched in Q1CY08 and has been delayed by a few months, Rotarix is scheduled for Q2CY08. Further GSK is also targeting to launch Cervarix vaccine in H1CY09.

• Further continuing its in-licensing strategy, Glaxo will launch an in-licensed cardiovascular product in H1CY08 and another in-licensed product in CY09. While the management has not disclosed details of these products, it has indicated that are likely to be fairly sizeable opportunities.

• Additionally, Glaxo is undertaking multiple initiatives to accelerate growth of the existing portfolio like enhancing focus on institutional hospital segment, sharply enhancing penetration of rural markets, using contract field force to push non-promoted products as also restructure the field force to increase focus on target segments like oncology, vaccines, CVS etc.

• In line with these initiatives, we estimate CY08 domestic sales growth of 10% for GSK

• Q1CY08 EBITDA margins at 36.4% are 30bps higher on a yoy basis while gross margins are flat yoy.

• Going forward, overall margin improvement should be limited given management’s cautionary outlook on margin expansion going forward given the growing inflationary pressures.

• Other income comprising primarily of revenues from clinical trials continues to grow strongly with 118% yoy increase to Rs. 217m in current quarter. This component has been growing steadily over the last few quarters and we expect it to continue to grow strongly with Glaxo Plc’s emphasis on leveraging India’s outsourcing advantages. For CY06, GSK India was allocated 8% of global clinical trial patients and this proportion is targeted to double over the
next 2-3 years. Glaxo is also establishing a facility for clinical data management for global operations in India.

• Adjusted net profit at Rs. 1213m was 9% higher on a yoy basis.


Valuations:

Glaxo is one of the strongest companies in the domestic pharma business sector. However Glaxo’s domestic pharma net sales growth of around 6-8% over the last few quarters including the recent one (which was also impacted by pipeline inventory adjustments) is significantly below industry growth of 11-12% growth. This is indicative of the challenges of driving growth in a mature product portfolio and limited new product launches. While the company has been taking multiple innovative steps to drive growth, we believe the company will find it difficult to grow faster than 12-13% per annum over the next few years till the time newer patented products start making a material impact of the financials.

Further pace of EBITDA improvement is likely to slow down with the escalation in inflationary pressures. Given this we believe that further acceleration in Glaxo’s profitability will largely depend on its ability to successfully launch patented drugs and vaccines and to drive topline growth. While we agree that Glaxo is clearly the best placed MNCs to leverage from IP era with its large size and rich pipeline of vaccines / patented drugs, we expect the impact of these newer products to start becoming visible only from CY10-11 onwards. In the near term there is limited room for upsides from current levels given the rich valuations and only 12%
CAGR in earnings growth over CY07-09. Maintain estimates and reiterate Neutral with a price target of Rs1045 (20xCY08E and 18xCY09E).

REPORT CARD:

PE ratio           16.03   25/04/08
EPS (Rs)          63.48   Dec, 07
Sales (Rs crore)      418.11   Mar, 08
Face Value (Rs)     10   
Net profit margin (%)  32.50   Dec, 07
Last bonus             1:1        28/09/95
Last dividend (%)   360      22/02/08
Return on average equity 39.5    Dec, 07