GSK Pharma: Regaining margins a tough task

Pricing restrictions on top products have dented sales growth, which will take a few quarters to revive

 

GSK Pharmaceuticals has been underperforming peers for the last few quarters and this does not look likely to change if the June quarter results are anything to go by. For the quarter, the company reported year-on-year domestic revenue growth of just under four per cent against sector growth of eight per cent. Most larger peers grew twice that of the sector’s rate.

The extended coverage of drugs under price control and heavier concentration of top drugs in its portfolio have dented revenue growth, realisations and margins. Pricing regulations meant 35 per cent of its products are under price control against 23 per cent. Its top 10 drugs contribute 38 per cent of its sales and these have seen steep price cuts by the regulator. While the company would be looking at volume gains from its more profitable basket and take increases on drugs out of price control, which will help regain some growth momentum, analysts at Espirito Santo say the initiatives will not yield immediate benefit.

While the price control continues to be the biggest impediment, the company has addressed issues hurting it over the last couple of quarters. These are supply problems for its vaccines and the margin dispute with dealers after the implementation of the new pricing regulations.

Given its brand strength and premium pricing, the company had enjoyed superior margins of 30 per cent plus. But after the price control, these have come down. In the June quarter, the margin number was 17.3 per cent. The margin fall has been the primary reason for earnings downgrades, with Citi Research cutting its CY14 earnings estimate for GSK Pharma 35 per cent. Analysts at the firm say margins could move up to mid-20s over the next couple of years as the company takes rises linked to inflation. The other lever it has is to improve volumes to overcome the pricing fall, but it will be a while before it can hope to achieve its earlier sector-leading profitability profile. Another option would be to launch new high-growth products that do not fall under price control. However, there is no clarity on launches.

Given the loss of pricing premium and no positive sales momentum in the short to medium term, most analysts have a sell on the stock, with a target price in the Rs 2,300-Rs 2,400 range. At Rs 2,494, the stock is trading at 31 times its CY15 earnings and is expensive, given the sales and margin outlook.