Glaxo India: Hold

Recommendation: Hold

Sanjiv Shankaran

ON THE heels of a strong financial performance of the second quarter of 2000, Glaxo's share price rose significantly to trade at Rs. 470.

In the light of the possibility of a good sales growth in the remaining half of the financial year, the stock price may display a firm trend. Therefore, shareholders may consider holding on to exposures.

Recent interest in the Glaxo stock has to be viewed from the standpoint of the lacklustre growth in the domestic pharmaceutical market last year, the company's exercise to strengthen its marketing arm, and renewed investor interest in pharmaceutical stocks after a sharp decline in prices earlier in the year.

Last year was one of the worst years for the domestic pharmaceutical market. Aggregate growth dropped on the heels of a lower incidence of ailments, and profitability was affected by severe price competition triggered by generic manufacturers. Pure generic manufacturers simply sell formulations (drugs in a ready-to-consume form) in its chemical name at lower price without taking the trouble to create a brand. The outcome was lacklustre growth for the top rung players.

In this backdrop, Glaxo restructured its marketing arm to derive mileage out of its portfolio of powerful brands. The marketing now revolves around therapies rather than individual products. Also part of the package was the decision to dispose of brands that did not fit the company's strategy. Consequently, the first-half income received a boost from the sale of three tail-end brands.

Another factor that boosted first-half sales by 19 per cent to Rs. 470 crores was the positive impact of the new marketing structure. When the first-half is broken up into two quarters, the sales growth of 28 per cent in the second quarter stands out.

Click here for Table

With the slow growth and attendant implications that dogged the Glaxo stock removed, sentiment at the counter has improved. At the moment, higher sales growth has not translated into improved profit margin. The matching growth in expenses has kept the operating profit margin flat at about 12.42 per cent. It may take longer before the changes made in the company's operating structure translates into higher profitability.

Traditionally, Glaxo has received a higher level of support from its parent, Glaxo Wellcome, than most other MNC pharmaceutical companies. Glaxo India's operations are in harmony with the group's global operations, with the domestic operation being viewed as a source for the global requirements.

Recently, at the global level, Glaxo Wellcome and SmithKline Beecham merged their operations to create a single pharmaceutical unit. The merger has imparted a new dimension to the company's valuation.

SmithKline Beecham's domestic operations have not received the same level of support that Glaxo has received. SmithKline Beecham also holds a lower level of equity in its Indian operations. As things stand, there is an element of ambiguity about the way the operations of Glaxo will unfold once merger-related changes start taking place.

The current share price is at a price earnings multiple (PEM) of about 36 times 1999's earnings per share (EPS) of Rs. 12.9. With signs of renewed investor interest in the pharmaceutical sector, Glaxo is likely to maintain a firm trend. However, considering the ambiguity about the merger, investors may consider avoiding higher exposures to the stock at this point in time.