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Sale of Vemgal plant

GlaxoSmithKline Pharmaceuticals Limited’s (GSKP) has announced the sale of its Vemgal plant located in Karnataka to Hetero Labs Ltd for a cash consideration of Rs1.8bn. Post discontinuation of Zinetac last year this plant remained unutilized and GSKP had announced a writeoff 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 target price of Rs1,575/share (earlier: Rs1,565/share).

* Hetero buys Vemgal plant: GSKP announced sale of its newly constructed manufacturing plant at Vemgal, Karnataka along with the land, plant and machinery, assets, software and equipment to Hetero Labs for a cash consideration of Rs1.8bn. The agreement is expected to complete within the next five days, however, transaction is expected to complete by Sep’21 post necessary approvals and formalities. 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 lead to severe underutilisation of the Vemgal plant which was yet to commercialise. In a prudent decision, GSKP impaired the asset to the tune of Rs6.4bn 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 that was market for sale stood at Rs3.75bn. The sale is announced for a cash consideration of Rs1.8bn. Hence, post the transaction, GSKP would record a loss of Rs1.95bn. 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 Rs5.4bn in FY21E and additional cash inflow of Rs1.8bn post the transaction.

* Outlook: FY21 estimates would optically appear lower due to Zinteac (ranitidine) sales in the base. However, we expect FY22 to report a 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 ~Rs20bn 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 target price of Rs1,575/share based on 40xFY23E earnings (earlier: Rs1,565/share). Key downside risks: addition of key drugs in NLEM, product concentration and government intervention.

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