GlaxoSmithKline Plc: Substantial foreign exchange loss impacts profitability

GSK recently released result for third quarter ended, September 2016 records notable decline in top-line earnings while profitability was negative. GlaxoSmithKline Consumer Nigeria Plc (GSK) is an affiliate of GlaxoSmithKline worldwide commenced operation on the 1st July 1972, under the name Beecham Limited and was subsequently quoted on the Nigerian Stock Exchange (NSE) in 1977 and is currently one of the 30 most capitalised stocks on the exchange. The Company has constantly advance innovations in products development and branding such as: the recently developed smaller pack sizes of inhaler devices for Asthma patients- Ventolin Rotacaps. Ventolin Rotacaps uses a re-engineered version of the established GSK inhaler technology that is five times less expensive to produce. The new inhaler has been made available in four markets –The Philippines, Indonesia, Kenya and Nigeria.

DECLINE IN REVENUE AS HOUSEHOLD CONSUMPTION SHRINKS

GSK has continued to face stiff competition from cheap imported healthcare and consumer goods from China and India besides local competition. This is in addition to reduction in sales witnessed in the North Eastern part of the country earlier in the year. Third quarter 2016 financial results of GlaxoSmithKline Consumer Nigeria Plc recently released shows a 10.85% decline in revenue to N20.54 billion from N23.04 billion in September 2015. The decline in top-line earnings triggered by the cautionary spending by households due to the domestic economic headwinds prevalent in the country has unarguably resulted in reduced general consumption. Hence, the GSK consumer healthcare goods - which deals with oral care, over the counter (OTC) medicine and nutritional healthcare – and pharmaceuticals – which deals in antibacterial, vaccines and prescription drugs - records sharp drop in sales by 12.41% and 7.55% respectively. Cost of sales also declined by 4.20% to N14.72 billion from N15.37 billion. Due to the lower decline in cost in comparison to revenue, gross profit weakened considerably by 24.18% to N5.82 billion from N7.67 billion recorded in the same period of 2015.

FOREIGN EXCHANGE LOSSES GREATLY ERODES PROFITABILITY

Operating profit recorded a loss of N6.29 billion in September 2016, indicating a substantial decline of 993.64% when compared with September 2015 figure of N704m. Forming a huge part of operating income is recovery of accrued licence fee of N1.22 billion payable to Glaxo Group Limited which was considered unnecessary. GSK’s profitability is largely eroded by an unanticipated loss recorded in other gains and losses to the tune of N6.47 billion from N653m in September 2016. Other gains and losses declined extensively on the back of unrealised foreign exchange losses totalling N5.85 billion. The Company’s total expenses figure revealed that administrative expenses, and selling and distribution expenses rose by 4.36% and 10.47% to N2.14 billion and N4.73 billion, from third quarter 2015 record of N2.05 billion and N4.29 billion respectively. The rise in selling and distribution expenses was incurred due to increased promotional activities by the Company’s management in a bid to further deepen the GSK brand and increase its market share in the highly competitive market in which it operates.

DESPITE INCOME FROM BUSINESS DISPOSAL, PROFITABILITY REMAINS NEGATIVE

Pre-tax loss stood at N6.29 billion indicating a decline of 997.09% from N701m in the corresponding period 2015. The company boast of reduction finance costs to N0.31m for the third quarter ended, September 2016 from N2.68m in the preceding period of 2015 indicating a massive decline of 88.56%. Net income was boosted by an unexpected income of N2.33 billion received from the disposal of its drink business through the sale of the Company’s two flagship brands; Lucozade and Ribena to Suntory Beverage & Food Nigeria Ltd. Nevertheless, a huge loss was still recorded as net income decline of 762.75% to N4.05 billion loss from N486m billion recorded in September 2015.

KEY FINANCIAL METRICS REFLECTS PERFORMANCE FIGURES

Total assets rose by 22.25% to N38.30 billion as at third quarter ended, 30th September 2016 from N31.33 billion as at December 2015. The growth was driven primarily by the substantial increase in cash and bank balances, trade and other receivables which grew by 543.06% and 19.95% respectively. Total liabilities also increased substantially by 62.65% to N29.51 billion from N18.14 billion as at third quarter ended, 30th September 2016. The growth in total liabilities was due to a massive rise of 71.36% in current liabities, despite a record loss of 7.16% in long-term liabilities. Shareholders equity decreased on the back of retained earnings by a notable figure of 33.34% in the period under review to N8.79 billion from N13.19 billion recorded in December 2015. Profitability ratio however dropped significantly. Return on average asset (ROAA) and return on average equity (ROAE) reflects bottom-line earnings as each stood at a negative 11.62% and 36.83% respectively as at third quarter ended, 30th September 2016. GSK’s quick ratio currently stands at 1.13 compared to 0.58 and 0.62 in September 2015 and December 2015 respectively. Furthermore, price to sales (P/S) positions at 0.64 while price book value (P/BV) at 2.05.

WE PLACE A HOLD RECOMMENDATION

The performance of GSK for third quarter of 2016 has not been impressive due to unprecedented foreign exchange losses, and reduction in both Company’s revenue and profitability. GSK still enjoys significant patronage across its product brands and Nigerian economy is an attractive market for consumable goods, largely supported by the growing population size of about 180.1 million people, which provides vast consumer demand. We hold strong opinion that GlaxoSmithKline Consumer Nigeria Plc has an opportunity to deliver high level of product innovations, operational excellence and create an opportunity to deepen its market which would significantly boost performance beyond current results. However, the Company’s management must review and action sound strategic plan towards improving revenue and effectively manage its expenses to positively impact further earnings and shareholders return. Considering the foregoing with respect to intense of and other macro-economic factors, we have valued the GSK’s share using a combined valuation methods of book value, and adjusted price to sales (P/S) which resulted in a 6-month target price of N12.55 per share. Since this represents a downside potential of 13.45% on the current stock price, we place hold recommendation on the Company’s shares.