GSK Pharma rating – Add: Sale of plant to improve return ratios

GlaxoSmithKline Pharmaceuticals Limited (GSKP) has announced the sale of its Vemgal plant located in Karnataka to Hetero Labs Ltd for a cash consideration of Rs 1.8 bn. Post discontinuation of Zinetac last year this plant remained unutilised and GSKP had announced a write-off on it. Company’s recent financial performance was healthy led by recovery in its key brands and supported by recently launched products (Fluarix Tetra, Menveo and Nucala). We expect this trend in recovery in the acute therapies to continue in the coming quarters. GSKP’s exposure only to domestic formulations, strong balance sheet and strong brand equity augurs well. Maintain Add with a revised TP of Rs 1,575/share (earlier: Rs 1,565/share).

Hetero buys Vemgal plant
GSKP has announced the sale of its plant at Vemgal, Karnataka, to Hetero Labs for a cash consideration of Rs 1.8 bn. The transaction is expected to complete by Sep’21. GSKP had intended to use ~60% of the manufacturing capability towards Zinetac (ranitidine); however, after the NDMA impurity issue, GSKP stopped its manufacturing and sale of the product in Sep’20. This would have led to severe underutilisation of the Vemgal plant which was yet to commercialise. In a prudent decision, GSKP impaired the asset to the tune of Rs 6.4 bn in its Dec’20 quarterly results and was exploring all options for the plant including sale.

Financial impact
Post the impairment, the book value of the asset stood at Rs 3.75 bn. Hence, post the transaction, GSKP would record a loss of Rs 1.95 bn. The transaction would remove unutilised asset and improve return ratios. Since, the company stopped manufacturing Zinetac at its existing plant in Nashik, there is no immediate requirement for a new plant, limiting the capex requirement. GSKP may announce higher dividend in FY22e to utilise its surplus cash after FCF of Rs 5.4 bn in FY21e and additional cash inflow of Rs 1.8 bn post the transaction.

Outlook for FY22
FY21 estimates would optically appear lower due to Zinetac (ranitidine) sales in the base. However, we expect FY22 to report strong growth both on revenue and earnings front. We expect 6.0% revenue and 11.3% PAT CAGR over FY20-FY23e driven by growth in power brands and key therapies like vaccines, respiratory and VMN. Minimal capex requirement would aid cashflow generation of ~Rs 20 bn over the next three years.

Valuations and risks
We marginally alter estimates to factor in effect from this transaction and maintain Add with a revised TP of Rs 1,575/share based on 40xFY23e earnings. Key risks: addition of key drugs in NLEM, product concentration and government intervention.