GSK Pharma: Unhealthy symptoms

Bogged down by operational issues, GSK Pharma posts lacklustre sales growth in Q3 CY06

GlaxoSmithKline (GSK) Pharmaceuticals' key pharma division reported lacklustre sales growth in the September 2006 quarter, as the company was bogged down by operational issues.

GSK's operating profit fell marginally on a y-o-y basis to Rs 137.5 crore in the September quarter, compared with 3.9 per cent drop in its operational income, including other income (mainly from clinical research work done for the global parent) to Rs 415.25 crore.

However, Q3 CY06 results are not strictly comparable with a year earlier, as the company had sold its animal health business effective from July 31, 2006.

Nevertheless, its operating profit margin rose 115 basis points y-o-y to 33.1 per cent in the last quarter. In the June 2006 quarter, the company's operating profit margin had fallen 190 basis points y-o-y to 34.27 per cent.

The sales growth in its key pharma division was below analysts' expectations "� segment sales improved marginally on a y-o-y basis to Rs 369.1 crore in the last quarter.

Analysts said the company was grappling with manufacturing problems faced by one of its key suppliers, which impacted sales growth.

Also, owing to the bunching up of several holidays in eastern India, which resulted in inadequate supplies in the region, about Rs 20 crore of the company's sales will be realised in the December 2006 quarter.

Segment profit of this division grew 5.6 per cent y-o-y to Rs 132.19 crore in the last quarter, on the back to tight control on costs.

The divestment of its animal health business will allow the company to allocate greater resources to the key pharma division. GSK is expected to launch several more vaccines in CY07, which should help drive its earnings. However, with the stock trading at 25 times estimated CY07 earnings, it is expensive.

Mid caps: To drive rally

Are mid caps back on investors' radar again? The current rally, which led the Sensex close at its all-time weekly high on Friday, has mostly been driven by a few large-cap stocks.

But this seems to be changing. Between mid-September "� when the index touched 12,000 "� and November 10, the Sensex has moved up 10.6 per cent. In the same period, the BSE-100, which has a larger basket of stocks, has been just on the heels of the Sensex, gaining 10.5 per cent.

But beyond this aberration, the broader market has done even better "� the BSE 500 has shot up 11.2 per cent, while the BSE 200 has gone up 10.9 per cent.

Obviously, many of the smaller stocks have attracted investor attention in the recent times. Corporate performance has been good in Q2, and smaller companies have better growth rates owing to a lower base.

This is evident from the 11.14 per cent growth in the BSE Midcap index. Over the past three weeks, the BSE Midcap has seen a consistent increase in the margin of its outperforming the market barometer Sensex since the low of June.

Analysts have started recommending mid caps as large caps have become expensive. So, if the rally continues, it will not be difficult to see mid caps in the driver's seat.

BEML: Input cost hurdle

Bharat Earth Movers (BEML) has benefited from strong demand conditions for its equipment for the irrigation and mining sectors, coupled with improved defence orders. Analysts, however, say the margins in the defence sector are lower than those in its other businesses.

The company has seen its operating profit zoom 93 per cent to Rs 49.4 crore in the September quarter, compared with a robust 71.5 per cent growth in net sales to Rs 607.59 crore.

While BEML does not provide a segment break-up of its quarterly sales, analysts said equipment for the mining and construction segment typically constitutes about 60 per cent of sales, while defence accounts for 30 per cent.

The company had to combat rising costs of non-ferrous metals in the September quarter, as well. As a result, raw material costs as a percentage of net sales jumped 1,495 basis points y-o-y to 71.4 per cent in the quarter.

The company made efforts to offset this by controlling staff costs and other expenditure, which fell only marginally, on a y-o-y basis. Its operating profit margin also, therefore, grew 90 basis points y-o-y to 8.1 per cent in the quarter..Going forward, the underlying concern for BEML is the rising cost of non-ferrous metals, which could put pressure on its operating margins.

The stock has been a major underperformer. It has declined nearly 40 per cent since March, while the Sensex has gained 23 per cent in the same period. Even after this fall, the BEML stock, which trades at 19 times its estimated FY07 earnings, looks expensive.