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Glaxo Misses, Guidance Lowered

Zacks Equity Research

GlaxoSmithKline (GSK) reported second quarter earnings of 79 cents per American Depository Share (ADS), well below the Zacks Consensus Estimate of 84 cents. Earnings fell 2.5% year over year. Revenues decreased 7.3% year over year to $10.2 billion. Revenues came in below the Zacks Consensus Estimate of $10.4 billion.

The Quarter in Detail

While the Pharmaceuticals and Vaccines sales fell 3%, the Consumer Healthcare sales remained flat. Price cuts in the EU affected the Pharmaceuticals and Vaccines revenues by 7% during the quarter.

While Pharmaceuticals and Vaccines sales increased in Japan (6%) and Emerging Markets and Asia Pacific/EMAP (9%), sales declined in the US (6%) and Europe (8%). Worldwide sales were affected by a number of factors including European austerity measures and weaker performance in the US due to generic competition and discontinuation of certain products.

In the Consumer Healthcare division, growth in Oral care (8%) and Nutritional (6%) was offset by a decline in the Total Wellness (8%) and Skin Health (2%) segments. Sales decreased in the US (11%) and Europe (5%) and increased in the Rest of the World (10%).

Glaxo continues to make progress with its cost-cutting initiative, which should help reduce the impact of increasing generic competition over the next few years and help earnings grow. The company remains on track to deliver £2.8 billion (of which £2.5 billion is already realized) in annual savings under its restructuring program by 2014. Apart from this, the company plans to generate annual cost savings of £500 million by the end of 2015 by improving operating efficiency.

Meanwhile, the company bought back shares worth £882 million during the second quarter of 2012. The company declared a dividend of about 53 cents per ADS. Total share repurchases in 2012 are expected to be between £2 billion and £2.5 billion.

Other Details

Glaxo is all set to complete its acquisition of Human Genome Sciences (:HGSI) in the third quarter of 2012 for $14.25 per share in cash. With this acquisition, Glaxo will gain full control over Benlysta and late-stage candidates such as darapladib (cardiovascular disease) and albiglutide (type II diabetes). Glaxo expects the acquisition to positively impact core earnings from 2013.

2012 Outlook

Glaxo expects revenues to remain flat year-over year (at CER). We note that earlier Glaxo was expecting revenues to grow from 2011 levels. Guidance was lowered due to EU pricing pressure. Going forward, Glaxo expects negative revenue growth in the third quarter of 2012 and positive revenue growth in the fourth quarter. Overall revenue growth in the second half of 2012 is expected to remain flat. Foreign exchange translations are expected to impact revenues by 1.5% in 2012. Additionally, core operating margin is expected to remain flat as compared with the year-ago figure. Previously, Glaxo had expected it to pick up in 2012.

The pipeline is expected to advance significantly with the potential launch of 8 candidates planned over a span of 2 years, two of which Nimenrix and Menhibrix have already received approval. The company is seeking or planning to seek regulatory approval for several candidates including Breo (regulatory review), albiglutide (regulatory submission planned in the first quarter of 2013), dabrafenib and trametinib (filing expected on July 30th).

Our Recommendation

A major part of Glaxo's revenues will be exposed to generic competition as multiple drugs are scheduled to lose exclusivity in the next few years. We expect the company's top line and gross margins to remain under pressure in the coming quarters. The US health care reform and EU pricing pressure will continue to affect sales.

We currently have an Underperform recommendation on Glaxo. The stock carries a Zacks #4 Rank (Sell rating) in the short run.

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