GlaxoSmithkline Consumer (a): Volume growth concerns allayed; GSK remains our preferred pick :: Kotak Sec

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GlaxoSmithkline Consumer (SKB)
Consumer products
Volume growth concerns allayed; GSK remains our preferred pick. GSK’s 2QCY11
was good, (1) likely ~16% volume growth (~5% in 1QCY11) and (2) operating leverage
in SG&A despite likely higher freight costs. Negative surprises were higher-thanexpected gross margin decline (290 bps to 59.4%) despite likely mix improvement
(likely faster growth in variants; unit realizations in some of the variants are >50%
higher than the base product, in our view) and higher adspends (up 33% yoy). Potential
for hike in payout ratio exists (currently ~40%). ADD.


Strong sales growth of 22%; operating leverage helps curtail EBITDA margin decline
GSK reported net sales of Rs6.5 bn (+22%, KIE Rs6.2 bn), EBITDA of Rs985 mn (+10%, KIE    
Rs1, 011 mn) and PAT of Rs825 mn (+15%, KIE Rs809 mn).
` 22% sales growth is likely driven by ~16% volume growth, in our view, the balance being
pricing growth and mix improvement (likely faster growth in variants; unit realizations in some
of the variants are >50% higher than the base product). The current quarter had the benefit of
5% price hike in November 2010. Horlicks likely had volume growth of ~15%.
` Gross margin decline of 290 bps to 15.1% is due to higher material cost (milk powder, barley).
However, operating leverage in other expenditure (216 bps saving) and staff cost (56 bps
saving) curtailed the EBITDA margin decline to 155 bps at 15.1%. Surprisingly, advertisement
and promotional spends increased 33% yoy (132 bps).
` Other income has increased 28% likely due to higher treasury yields and higher other operating
income (likely higher distribution income of Sensodyne).
` The company has recently appointed Mr Jayant Singh as Marketing Director (he was MD of
Henkel India prior to this posting).
Key monitorable (1) volume growth, (2) margin management, (3) likely fatigue of new launches
` Volume growth. After a weak 1QCY11 (+5%), the volume growth in 2QCY11 has bounced
back and is on the back of +10% in 2QCY10. This is commendable given the overall
inflationary scenario and is inline with our thesis that malted food drink (MFD) is shifting from
being a discretionary spend to a necessity. Horlicks being the market leader in the segment is a
likely beneficiary of higher category spends.


` Margin management. While input cost environment continues to remain inflationary,
we believe that company has sufficient head room to manage margins driven by savings
in adpro spends (CY2010 had a high base of 15% due to relaunch of the Horlicks
portfolio and new launches). We model EBITDA margin of 16.8% for CY2011E and
16.6% for CY2012E.
` New launches. Foodles was launched nationally last year and had ~6% market share in
south and east India. Gaining incremental market shares is critical especially given the
high brand investments made. Boost Glucose launched last year is likely to be in the
ramp-up mode in CY2011-12E, in our view. It may have gained some market shares as
Dabur posted flat sales growth for its health supplements portfolio (which includes
glucose) this quarter.
While GSK had launched multiple new products such as Actibase, Actigrow, Horlicks Chill
Dood, Nutribar, cream biscuits, Foodles etc, our optimism had always been on the
potential of the malted food drink category (MFD). Most of its new launches (other than
in MFD) are likely witnessing signs of fatigue, in our view.
Retain ADD, GSK remains our preferred pick
We maintain our ADD rating and positive bias on GSK. Our estimates are broadly
maintained and we retain target price of Rs2,700. Our EPS estimates are Rs85.7 and
Rs101.9 for CY2011E and CY2012E, respectively. Potential for increase in payout ratio exists.
Key risks to our ADD rating are input cost inflation and slow volume growth in malted food
drink category