GlaxoSmithkline Consumer Healthcare (Q2 CY12)

CMP Rs2,720, Target price Rs3,119, Upside 14.7%

• GSK Consumer recorded modest 11.7% yoy growth during Q2 CY12 at Rs7.3bn (marginally below our expectation of Rs7.6bn). GSK witnessed muted volume growth at 3.2% primarily due to flat army’s canteen stores division (CSD) sales and 12% yoy decline in exports.
• Domestic sales grew by 15% yoy to Rs6.6bn (despite flat CSD sales) driven by 7% volume growth and 8% price hikes. Adjusting for the CSD sales, revenue and volume growth was strong at 16% and 8.2% respectively. Export sales declined by 12% yoy mainly due to high base effect (58% yoy increase in Q2 CY11 due to order rescheduling from the Middle East).
• The key brand - Horlicks registered 12% yoy growth - ~8% yoy price and 4% volume growth. Boost reported an impressive ~22% yoy growth (11% volume growth) on.
• The biscuits portfolio recorded strong 27% yoy growth (~Rs365mn) during the quarter. While the oats segment saw a satisfactory ramp up. Horlicks Oats maintained its No 3 position in South India with 11.3% market share (marginally down from 12% in Q1 CY12). Foodles clocked revenues of Rs50mn during the quarter (GSK has shifted focus to niche multi-grain offering which earns higher gross margins, but not competing in the mass noodles segment).
• Operating margins remained flat at 15.2% due to sharp 250bps increase in overhead cost. A 360bps drop in raw material cost restricted further margin erosion. Overall input cost inflation for the quarter was at ~6.5% yoy with skimmed milk powder, malted barley and sugar witnessing 10%/8%/4% yoy increase in prices respectively (wheat flour prices remained flat). The company has taken ~8% price hike during the quarter to offset the input cost impact.
• GSK plans to maintain its adspend to sales ratio at ~15-16% level as it will further ramp up new products. We expect the company to mitigate the input cost and higher adspend pressure with price hikes and maintain/improve operating margins going forward.

Cost Analysis

• Net profit for the quarter matched our expectations by recording 29.3% yoy increase at Rs1.1bn partly by higher other income. Other income for the quarter was higher at Rs572mn against Rs360mn in Q2 CY11 (includes business income and cross-charge received on account of OTC products sold on behalf of GlaxoSmithKline Pharmaceuticals Ltd – Rs250mn against Rs180mn in Q2 CY11).
• After factoring in lower domestic (CSD impact) and exports growth for H1 CY12, we have lowered our revenue/PAT estimates for CY12 and CY13 by 2.5%/1.4% and 4%/3.3% respectively.

• With zero debt on its books and operating cash flows of ~Rs3-4bn per annum, GSK is a cash-rich company. Low penetration levels in the core Malted Food Drinks category will provide surplus headroom for growth for GSK. GSK has planned a capex of Rs1.3-1.4bn in CY12E out of which Rs450mn was spent in Q2 CY12. The new plant in Sonepat will go on stream in H1 CY13, producing 18,000 tons, sufficing its demand for ~1.5 years. GSK has increased its direct distribution reach to 700,000 outlets from 600,000 last year. GSK is also increasing focus on rural market, currently contributing ~25% to its total sales, with specialized combo packs and increased distribution. We expect GSK to register earnings CAGR of 19.5% over CY11-13. The management’s confidence of sustaining volume growth and margins reaffirms our view. At the current market price of Rs2,720, the stock is trading at 22.5x CY13E EPS of Rs120.7. We maintain BUY, with a 9-month price target of Rs3,119.