Emkay Global Financial Services downgraded GlaxoSmithKline Pharma to `Reduce` with a price target of Rs 1,714 as against the current market price (CMP) of Rs 2,110 in its report dated Nov 4, 2011. The broking house gave the following rationale:

Decline in profitability led by higher material cost and other expenses:

EBIDTA margins contracted by 687bps YoY to 30% on account of- > Higher raw material cost (up 12% YoY, 266bps expansion) and> Other expenses (up 24% YoY, 316bps expansion).PAT de-grew 8% to Rs 1.5 billion

Impact of proposed drug price control policy:

The government’s new proposed drug price control policy will bring 60% of the domestic market under direct price control. Among the pharma companies GSK will be the most affected with ~67% of its portfolio falling under the price control regime which will have Rs 1.5 billion impact on the top-line. The major brands which will be impacted are Augmentin, Zentel, Banocide, Betnovate, Neosporin, Zinetac, Zovirax, Eltroxin, Betnesol and Calpol. However, we have not factored-in any downsides from price control policy in our estimates.

Valuation:

We expect GSK to report 7% revenue growth in CY11 and 12% growth in CY12. We expect EBIDTA margins to contract from 35.31% in CY10 to 31.6% in CY11 and 32.9% in CY12. Earnings will grow at a CAGR of 7% to Rs 6.7 billion. We revised our target on the stock to Rs 1,714 and downgrade the stock one notch to Reduce. At CMP, the stock is trading at 31x/27x CY11E/CY12E earnings respectively.

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