Glaxo: A healthy start

Recommendation

Glaxo India: Hold/Buy on declines

India Nippon Electricals: Buy

Sanjiv Shankaran

IN THE last few weeks, virtually all companies at the cutting edge of silicon technology have lost their sheen.

Along with IT, the prices of stocks have declined sharply across the board. In this milieu, investors may consider taking a look at select companies in sectors where it may be possible to find stocks undervalued from a medium-to-long-term perspective. In this context, the stocks of Glaxo (India) and India Nippon Electricals can be considered.

Glaxo

The Glaxo scrip trades at Rs. 415, a sharp fall of a little over 50 per cent in the last six months. At the current level, the company trades at a price-earnings multiple of 45 times its sustainable earnings per share for 1999.

Glaxo has long been a leader in the industry. However, the dominant presence has not translated into a significant growth either in sales or net profits. For instance, in the last three years, the sales grew at a compound rate of 11.16 per cent to Rs. 886 crores in 1999; a growth rate lower than the industry average of 15 per cent for the same period.

The company's financial performance was hampered by moderate growth of a mature product basket, and to compound matters, about 60 per cent of it comprises drugs that fall within the ambit of price control. The presence of a large proportion of products under price control restricts the flexibility and also leaves the company vulnerable to a downward revision in price by the pricing authority.

About 51 per cent of Glaxo India's equity is controlled by the parent, Glaxo Group, UK. The critical advantage of the relationship is that the Indian company may source blockbuster drugs from the parent. For Glaxo, as also other pharmaceutical MNCs, the advantage is neutralised by the lack of patent protection for drugs sourced from the parent. This situation is expected to change over the next five years when the Patents Act is amended, but till then, the MNCs can capitalise on the relationship with the parent only in a limited way.

In this milieu, Glaxo still has a few inherent advantages that may have a positive impact on the earnings growth in the medium term. After the sharp slowdown in the growth of the domestic pharmaceutical market last year, Glaxo picked its marketing arm for special attention so as to boost sales. In a market characterised by a number of brands and heavy price-led competition, Glaxo took on the marketing function as one that can increase sales. Towards this end, it completed an overhaul of its field-force -- perhaps, the company's core strength in the current patent regime.

Glaxo hopes to achieve a 20 per cent growth through the overhaul of its marketing arm. Not just the qualitative aspect, the company is also in the process of enhancing the effect of its field-force by increasing the size to about 2,000. The likely boost to earnings from the realigned field-force and a move into faster growing therapeutic segments may have a positive impact on the share price in the medium term.

Investors may consider holding on to the stock at the present level because of the possibility of the increase in earnings in the medium-to-long-term which, in turn, may have a positive impact on the share price.

India Nippon Electricals: Good spark

India Nippon Electricals makes electrical ignition systems in technical collaboration with Kokusan Denki of Japan, which typically finds application in two-wheelers and portable gensets. The Japanese collaborator holds about 20 per cent stake in the company. India Nippon is the market leader in the industry and its original equipment clientele includes two-wheeler majors such as TVS-Suzuki, Bajaj Auto, Hero Honda and Kinetic Honda. The company caters to the portable genset manufacturers as well. Denso India is the main competitor to the company.

Given that India Nippon derives the bulk of its revenues from the two-wheeler segment, it is not all that surprising to see a steady improvement in the company's performance in recent years. Two-wheeler output has improved steadily on the back of the burgeoning middle-class population.

The pressure on the public transport system has also spurred two-wheeler demand. Aided by the robust growth in the demand for two-wheelers, India Nippon managed to post a steady improvement in financial performance. The sharp growth in the offtake of TVS-Suzuki's products, in particular, has been instrumental in India Nippon's steady growth in recent years.

For the year-ended March 1999, the company's turnover grew 20 per cent to Rs. 88.01 crores, while the post-tax earnings improved 21 per cent to Rs. 9.09 crores. Consequent to the bonus issue (8:5), the equity capital rose from Rs. 1.98 crores to Rs. 5.15 crores.

The thrust on research and development and the backing of the technical collaborator helped the company broadbase its product portfolio. In-house design facilities and the integrated nature of operations helped the company cater also to the customised needs of its customers.

The company has also entered into a new technical collaboration agreement with Kokusan Denki to produce digital ignition systems for four-stroke engines. Given the growing popularity of four-stroke two-wheelers, this move is likely to lead to positive results.

On the flip side, any slowdown in the offtake of two-wheelers could have a significant impact on India Nippon's financials. However, there are no signs of any slowdown in the two-wheeler sector. The two-wheeler output is projected to grow at 12-15 per cent with the motorcycle sector taking the lead and growing at a faster pace. With its new plant at Pondicherry commissioned recently (in 1997-98), India Nippon appears well-positioned to tap the anticipated growth in volumes.

Given the growth potential and its entrenched position in the industry, long-term investors could contemplate exposure in Indian Nippon Electricals' stock at the current level of Rs. 227.