GSK India reported lackluster Q3CY10 with sales growth of 14% with EBITDA margins declining 104bps leading to tepid 11% growth in EBITDA. Lower depreciation & higher interest income boosted recurring PAT growth of 12%.

Sales growth driven by vaccines and focus brands Vaccines has grown 34% and accounted for 8% of the sales for the quarter on the back of improved traction of Rotavirus and Cervarix. Pharma sales growth (ex vaccines) at c13% appears moderate given the strong +20% growth in the Indian pharma market during the JAS’10 quarter. Key brands like Calpol (paracetamol), Augmentin (anti biotic) and Neosporin (Eye drops) grew by 15%.

Margins continue to remain under pressure Gross margins declined by 187bps on adverse product mix. Lower staff cost arrested some of the margin decline with EBITDA margins declining
104bps. EBITDA margins will come off in the coming quarter on higher costs both RM costs and other expenses. We note that GSK India imports some of the patented products from its parent (GSK Plc) and as new patented products are launched the RM cost may go up.

Growth trajectory to remain muted We believe revenue contribution from patented products would be <5% of sales over the next three years. Product margins would be lower than those in the existing business due to cost of development (undertaken by parent) recovered from GSK India. Consequently, new patented launches may not shift the growth trajectory drastically over the next three years.

VALUATIONS AND RECOMMENDATION Management has guided towards 14%-15% sales growth guidance with margins at 33-35% (v/s current 36%). GSK India expects to launch 2 products - Revolade (drug for low platelets) and Votrient (metastatic renal cell carcinoma) in the Q1CY11.

Valuations at 28xCY11e consensus estimates are expensive relative to the sector (22x FY12e) as well as with other pharma MNCs. We do not find value at current levels especially given the mid teens growth outlook. We retain our estimates while roll forward our TP to Dec’11 earnings and derive TP at Rs1,742. Our target price entails 23% downside to the CMP. We maintain our ‘SELL’ recommendation.