The Hindu Business Line : GlaxoSmithKline Pharma: Buy

GLAXOSmithKline Pharma (Glaxo) has turned in a robust performance for the quarter ended March 2004. On the back of a 21 per cent growth in its pharmaceutical business on a year-on-year basis (double the rate at which the overall pharma market grew that quarter), there was strong buoyancy at the operating level with a further firming up of margins. Net profit, too, has jumped 60 per cent to Rs 56 crore.

Glaxo's prospects continue to be positive. Along with Aventis Pharma, Glaxo would be the preferred pick among the pharma MNCs in the domestic market. In terms of price, the Glaxo stock has shed a few percentage points since the earlier buy recommendation in March.

The recent fall in price on account of market volatility has only enhanced the stock's attractiveness.

We reiterate our buy rating on the stock as it holds good potential for appreciation from a medium-term perspective.

With a new dispensation set to take charge at the Centre, the pharma sector — unlike other sectors such as oil and gas, telecom, power or infrastructure, which are to a large extent influenced by reform pressures — is not likely to see any nasty negative surprises.

In an uncertain policy environment, the pharma sector could emerge as the classic defensive play and frontline stocks in this sector, such as Glaxo, could be expected to remain investor picks of choice.

From the industry's perspective, the key legislation would be on whether there is an increase in the number of drugs that fall outside the scope of price control. Currently, pharma MNCs derive more than a quarter of revenues from price-controlled drugs.

Any move by the Government to bring more drugs under price control would be a negative; the converse could have a salutary impact on the earnings stream of such companies. In any case, Glaxo has increasingly been following a `power brands' strategy that attempts to maximise the potential of products that are outside price control.

And if the trend in operating margins is any indication, the strategy appears to be paying off handsomely.

Operating margins for the latest quarter have risen almost 600 basis points to 23.5 per cent, year-on-year. It is pertinent to note that in the first quarter of the previous fiscal, too, margins had risen about 440 basis points.

Going forward, a further expansion of operating margins could be on the cards as power brands start contributing incrementally more to revenues. The substantial improvement in margins has been brought about by a sharp improvement in operating efficiencies (post the closure of Burroughs' uncompetitive plant at Mulund) as well as a focus on costs, manifest in the reduction of raw material and staff costs and other expenses (reckoned as a percentage of sales).

The Burroughs story for the quarter is equally impressive. On the back of a strong showing by the flagship paracetamol brand Calpol, its topline grew a shade over 30 per cent; and the bottomline by a more impressive 72 per cent, driven largely by a more than 50 per cent cut in staff costs.

Interestingly, with the swap ratio of 14 Glaxo shares for every 10 shares held of Burroughs, investors could look at the possibility to buying into Glaxo using Burroughs as a proxy, as this would lower the effective acquisition cost.

Glaxo's coffers are also healthy, what with the disposal of the property at Worli and the sale of the Mulund factory in the works. Investors could expect a significant one-time dividend or expect the money to be returned to them through the buyback route, if Glaxo's shareholder-friendly moves of the past are an indication.

With the domestic market environment also expected to remain favourable, the solid cash position should be an added source of comfort to prospective investors.

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