Motilal Oswal : Buy GlaxoSmithKline Consumer Healthcare

(BSE: 500676 | NSE: GSKCONS | ISIN: INE264A01014)

GSK Consumer’s 3QCY07 results were above expectations, with 16.6% increase in net sales and 39.5% PAT growth in comparison to our estimates of 12.8% and 12.1%, respectively.

Consistent price hikes and cost control resulted in 180bp margin expansion. EBITDA margin for the quarter was 19.3%. Other income grew 50% to Rs209m, mainly led by increase in income from mutual fund investments. PAT grew 39.4% to Rs505m.

The management has guided 7-8% volume growth and 12% sales growth in CY08. Milk and wheat prices are expected to remain strong due to global shortages. Management seems confident of passing on upto 5% price increase to the consumer without any impact on demand.

We expect the company to maintain market share in the malted food market in India, despite entry of new players (Dabur) and aggressive product promotion plans of existing players like Nestle. We are revising our EPS estimates to Rs39.5 for CY07 from Rs34.5 and to Rs46.2 for CY08 from Rs39.1. The stock trades at 15.9x CY07E and 13.6x CY08E earnings. We maintain Buy .

Strong growth momentum continues in 3QCY07 GSK Consumer maintained strong underlying growth across brands. Sales volumes grew by 7% both for Horlicks as well as Boost . Gross sales growth also included the benefit of close to 5.5% price increase affected during the course of the year. The company has indicated that the growth momentum will continue. Competitive landscape continues to be favorable with emphasis on innovation, marketing and geographical expansion being ahead of the competitors. GSK maintained around 70% market share in the malted drinks market. The company plans to expand its reach in the rural area by launching small SKUs. Low-priced small SKUs can attract large number of first-time users.

Raw material price on an uptrend… Prices of all the key raw materials like wheat, barley and milk have been rising. Price of skimmed milk has been 25% higher on YoY basis, while that of wheat has been 15% higher. Drought in some of the key milk producing countries like Australia and New Zealand is expected to keep prices high. In addition, the removal of ban on the export of skimmed milk powder will result in price increase. Wheat production has been showing staid growth in India. In addition, some of the large exporters like Australia have lower area under wheat cultivation, thus reducing export surplus. Consequently, wheat prices are expected to rule firm in the medium term.

"… but consistent price hike resulted in margin expansion" adds Motilal Oswal. Due to its strong brands and leadership position, GSK Consumer has been able to pass on the raw material cost- push by increasing prices on a consistent basis. During the year, the company has taken an effective price hike of 5.5%. During the quarter, higher realization resulted in 160bp increase in gross margin while cost control enabled a 180bp EBITDA margin expansion. Management is confident of passing on upto 5% price increase to the consumer without any impact on demand.

Launch of new products would provide scalability GSK plans to bring in few products from its parent company in CY08. Further, the company is also planning to launch new products in during CY08. We believe this would provide scalability.

Valuation and view We expect the company to maintain market share in the malted food market in India, despite entry of new players (Dabur) and aggressive product promotion plans of existing players like Nestle. We are revising our EPS estimates to Rs39.5 for CY07 from Rs34.5 and to Rs46.2 for CY08 from Rs39.1. The stock trades at 15.9x CY07E and 13.6x CY08E earnings. We maintain Buy .

GlaxoSmithkline Consumer: an investment profile Company description GSK Consumer is the largest player in the Rs13b Indian health foods market, with a 70% market share with brands like Horlicks, Boost, Viva and Maltova. The malted foods
market is expected to grow at 7-8% in volumes. The company has launched Horlicks Lite targeted at health conscious adults, a product positioning its shrugged off few years back.

Key investment arguments We expect an EPS CAGR of 20% over CY05-07E, driven by new product launches , selective price increases and benefits of lower excise duty from third party packaging units.

Cash rich company with Bank FD’s of Rs 36 per share, looking for higher yield investments and acquisitions.

Key investment risks Commodity linked prices of Milk and Milk solids, Malt and Sugar are the key raw material and can have significant bearing on the margins of the company. GSK Consumer drives 95% sales from Malted drinks, a product category which is growing in mid to high single digits only. The dependence on single product segment is key risk to future growth.

Recent developments GSK Consumer relaunched Horlicks in a new formulation that claims to make children ‘Taller, Sharper and Stronger’. Chocolate Horlicks and Junior Horlicks were also re-launched in new packaging. The company initiated a new advertising campaign during the quarter for Horlicks- ‘ Exam ka bhooth bhagao’

Valuation and view We have EPS forecasts of Rs39.5 for CY07 and Rs46.2 for CY08. The stock is currently valued at 15.9x CY07E EPS and 13.6x CY08E EPS. We maintain Buy .

Sector view We are positive on the sector. The sector is showing strong volume growth across product categories with improving pricing power for leading players. Companies with low competitive pressures and broad product portfolios will be able to better withstand any slowdown in a particular segment. Longer term prospects bright, given rising incomes and low penetration.

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