Flps homework

Europe Equity Research 24 July 2008

GlaxoSmithKline Underweight GSK - 2009: Another trough year, EPS trimmed 6- 7% from '09 onwards

1,228p 23 July 2008 Price Target: 1,050p

Pharmaceuticals Alexandra HauberAC (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

Alistair Campbell (44-20) 7742-6653 alistair.d.campbell@jpmchase.com

Richard Vosser (44-20) 7742-6652 richard.vosser@jpmorgan.com

Lucinda Seagrove (44-20) 7742-6656 lucinda.seagrove@jpmorgan.com

J.P. Morgan Securities Ltd.

For Specialist Sales advice please contact: Marjan Daeipour (44 20) 7325-3281 marjan.daeipour@jpmorgan.com

GlaxoSmithKline (GSK.L;GSK LN) 2006A 2007A 2008E 2009E 2010E Adj. EPS FY (p) 97.34 101.21 103.10 100.12 108.94 Adj P/E FY 12.6 12.1 11.9 12.3 11.3 EBIT FY (£ mn) 7,864 7,981 7,891 7,548 8,051 EBITDA FY (£ mn) 8,977 9,167 9,031 8,779 9,365 Headline EPS FY (p) 95.50 99.07 100.15 97.09 106.16 Headline P/E FY 12.9 12.4 12.3 12.6 11.6 Revenue FY (£ mn) 23,225 22,716 22,977 22,607 23,465 Pretax Profit Adjusted FY (£ mn)

7,799 7,788 7,481 6,952 7,413

Source: Company data, Reuters, JPMorgan estimates.

Company Data Price (p) 1,228 Date Of Price 23 Jul 08 52-week Range (p) 1,403 - 987 Mkt Cap (£ bn) 66.0 Fiscal Year End Dec Shares O/S (mn) 5,375

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• GSK reported 2Q08 results yesterday, bang in line with our forecast, but 7% ahead of consensus.

• Incoming CEO Andrew Witty explained his 3 key strategic priorities for GSK in a 2 hour analyst meeting. Whilst plausible, those priorities offer little tangibles for investors, in our view.

• Buyback programme paced to create room for business development activities. Buyback for 2008 is cut back from £6bn to £3.5bn, leaving GSK with another £5.5bn buyback to be completed sometime after 2008. No timelines for buybacks beyond 2008 were provided.

• Disposal gains create a tough comparison for 2009. 2008 Guidance was maintained despite lower buybacks. We estimate that GSK needs significant disposal gains to plug the gap left from reduced buy backs.

• 2009: Another Trough Year? In view of a (1) lower boost from buybacks, (2) a tough ’08 base from high disposal gains (3) still significant generic erosion (Paxil CR, Requip, Lamictal, Imitrex, Valtrex), (4) no major new product launches in 2009 (US Cervarix launch pushed to 2010), 2009 should be another year of declining EPS.

• Model Review: We have trimmed EPS by 6-7% from 2009 onwards. Our new estimates are 6-12% below consensus for 2009E- 2012E (see Table 4).

• Valuation: Most Expensive Pharma Stock: Investors should sell into the recent sector rotation based strength.

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Europe Equity Research 24 July 2008

Alexandra Hauber (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

2Q’08 Results Quick Recap GSK reported 2Q08 results yesterday, bang in line with our forecast (7% ahead of consensus). As expected, consensus had underappreciated the FX effect and over- estimated the 2Q08 gross margin compression.

Table 1: Q2 P&L; Reported vs JPMe & Consensus (£m, unless otherwise stated) 2Q08A JPMorgan

2Q08E % difference Cons 2Q08E % difference 2Q07A % y-o-y growth

Total Sales 5874 5,948 -1.2% 5,685 3.3% 5,674 3.5% y-o-y growth (CER) -4.5% Pharma Total sales 4923 5,000 -1.5% 4,775 3.1% COGS -1375 -1,376 -0.1% -1,355 1.5% -1,212 13.4% Gross Profit 4499 4,572 -1.6% 4,330 3.9% 4,462 0.8% Gross Margin 76.6% 76.9% 76.2% 78.6% SG&A -1765 -1,780 -0.8% -1,724 2.4% -1,841 -4.1% R&D -802 -850 -5.6% -815 -1.6% -789 1.6% Other Operating Income 194 194 0.0% 192 1.0% 97 100.0% Operating Profit 2126 2,136 -0.4% 1,983 7.2% 1,929 10.2% Operating Margin 36.2% 35.9% 34.9% 34.0% Profit before tax 2023 2,046 -1.1% 1,896 6.7% Net profit 1425 1,425 0.0% 1,333 6.9% Basic EPS (p) 27.2 27.2 -0.2% 25.5 6.8% 23.9 13.7% y-o-y growth (CER) 7.7% Diluted EPS (p) 27.0 27.0 0.0% 23.7 13.9% Source: JPMorgan estimates, Company data.

Three Strategic Priorities for new CEO Incoming CEO Andrew Witty explained his 3 key strategic priorities for GSK in a 2 hour analyst meeting.

1. Grow a diversify global business

2. Deliver more products of value

3. Simplify GSK’s operating model

Whilst plausible, those priorities offer little tangibles for investors, in our view. Investors who had hoped for significant changes as a result of the new leadership at GSK may be disappointed.

£5.5 bn of £12 bn buy back programme delayed with undefined timelines GSK announced that the share buy back programme announced by Andrew Wittey’s predecessor JP Garnier 1 year ago at 2Q'07 results will be ‘paced’ to create room for business development activities. The buy back programme for 2008 will be cut from £6bn to £3.5bn, leaving GSK with only £1bn to go in the remainder of 2008 and another £5.5bn to be completed sometime after 2008. No timelines for buybacks beyond 2008 were provided. In our new model we assume GSK will repurchase £3bn shares in ’09 and a further £2.5bn in 2010E.

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Europe Equity Research 24 July 2008

Alexandra Hauber (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

Disposal gains should create a tough comparison for 2009. 2008 Guidance was maintained despite lower boost from buybacks. (FY 2008 guidance remains: “mid single digit decline in business performance EPS”, with a 7% boost from FX at current FX rates).

With operating performance broadly inline with guidance provided in a February, the gap from lower buybacks (c. 2% in 2008) will most likely be made up by disposal gains within ‘Other Operating Income’.

2009: Another Trough Year? In view of a

(1) Lower boost from buybacks,

(2) A tough base from high disposal gains in ’08,

(3) Still significant generic erosion (Paxil CR, Requip, Lamictal, Imitrex, Valtrex),

(4) No major new product launches in 2009 (US Cervarix launch is pushed to 2010),

We now expect 2009 to be another year of declining EPS.

Changes to Estimates We have trimmed EPS by 6-7% from 2009 onwards. Our forecast for 2008E was modestly increased to reflect a stronger FX effect (7% rather than 5-6% on EPS).

Table 2: GSK – Business performance EPS Change Table (pence, unless otherwise stated)

2008E 2009E 2010E 2011E 2012E Basic EPS - New 100.1 97.1 106.2 111.8 112.4 Basic EPS - Previous 99.0 103.4 113.6 120.1 120.7 % Change 1.1% -6.1% -6.6% -6.9% -6.9% Source: JPMorgan estimates, Company data.

Table 3: GSK – Business Performance Diluted EPS Change Table (pence, unless otherwise stated) 2008E 2009E 2010E 2011E 2012E

Diluted EPS – New 99.4 96.1 104.9 110.2 110.6 Diluted EPS – Previous 98.2 102.3 112.2 118.3 118.7 % Change 1.2% -6.1% -6.5% -6.8% -6.8% Source: JPMorgan estimates, Company data.

Lower buybacks are responsible for 4-5% of the cut; the remainder results from lower sales projections (see Tables 5, 6 and 7 for details).

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Europe Equity Research 24 July 2008

Alexandra Hauber (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

Table 4: Summary of Key P&L Changes 2006 - 2012E (£m, unless otherwise stated) 2008E 2009E 2010E 2011E 2012E

Net Sales - New 22,977 22,607 23,465 24,413 24,474 Net Sales - Previous 22,952 22,950 23,795 24,770 24,852 % Change 0.1% -1.5% -1.4% -1.4% -1.5%

COGS - New (5,482) (5,588) (5,802) (6,109) (6,240) COGS - Previous (5,462) (5,640) (5,855) (6,165) (6,304) % Change 0.4% -0.9% -0.9% -0.9% -1.0%

Gross Profit Margin - New 76.14% 75.28% 75.27% 74.98% 74.50% Gross Profit Margin - Previous 76.20% 75.42% 75.40% 75.11% 74.63% bp change -6 -14 -12 -13 -13

SG&A - New (6,916) (6,760) (6,781) (6,954) (6,936) SG&A - Previous (6,977) (6,862) (6,877) (7,055) (7,044) % Change -0.9% -1.5% -1.4% -1.4% -1.5%

R&D - New (3,309) (3,255) (3,379) (3,564) (3,622) R&D - Previous (3,330) (3,305) (3,427) (3,616) (3,678) % Change -0.6% -1.5% -1.4% -1.4% -1.5%

Other Operating Income - New 580 500 500 500 500 Other Operating Income - Previous 475 475 475 475 475 % Change 22.1% 5.3% 5.3% 5.3% 5.3%

Operating Profit - New 7,851 7,504 8,002 8,286 8,176 Operating Profit - Previous 7,657 7,618 8,112 8,408 8,301 % Change 2.5% -1.5% -1.4% -1.5% -1.5%

Operating Profit Margin - New 34.17% 33.19% 34.10% 33.94% 33.41% Operating Profit Margin - Previous 33.36% 33.19% 34.09% 33.95% 33.40% bp change 81 0 1 0 0

Profit Before Tax - New 7,481 6,952 7,413 7,764 7,800 Profit Before Tax - Previous 7,300 7,107 7,608 8,028 8,065 % Change 2.5% -2.2% -2.6% -3.3% -3.3%

Profit attributable to shareholders - New 5,257 4,884 5,218 5,473 5,503 Profit attributable to shareholders - Previous 5,092 4,959 5,320 5,622 5,652 % Change 3.3% -1.5% -1.9% -2.7% -2.6%

EPS (reported) - New 100.1 97.1 106.2 111.8 112.4 EPS (reported) - Previous 99.0 103.4 113.6 120.1 120.7 % Change 1.1% -6.1% -6.6% -6.9% -6.9%

EPS (diluted) - New 99.4 96.1 104.9 110.2 110.6 EPS (diluted) - Previous 98.2 102.3 112.2 118.3 118.7 % Change 1.2% -6.1% -6.5% -6.8% -6.8%

EPS change attributable to reduced buy-back -2.1% -4.6% -4.7% -4.2% -4.2% Source: JPMorgan estimates, Company data.

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Europe Equity Research 24 July 2008

Alexandra Hauber (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

Table 5: Sales Forecast Changes (£m, unless otherwise stated) 2007E 2008E 2009E 2010E Contrib to

09E Chg Comments

Respiratory New 5,032 5,520 5,739 6,036 Y-o-Y Growth (%) 10% 4% 5% Previous 5,032 5,416 5,770 6,100 Absolute Change 0 104 -31 -64 9% Advair ROW increased offset by cuts in the US and % Change 0.0% 1.9% -0.5% -1.0% Veramyst cuts due to underwhelming US performance so far CNS New 3,348 2,686 1,621 1,696 Sales decline expected to due generics for Requip, Paxil CR, Imitrex, Lamictal Y-o-Y Growth (%) -20% -40% 5% Previous 3,348 2,662 1,716 1,742 Absolute Change 0 23 -95 -46 28% % Change 0.0% 0.9% -5.5% -2.6% trimmed Lamictal XR forecast as product is launched after generics Anti-Virals New 3,028 3,026 2,628 2,122 Loss of Valtrex in 2009 Y-o-Y Growth (%) 0% -13% -19% Previous 3,028 2,975 2,585 2,086 Absolute Change 0 51 43 35 -12% % Change 0.0% 1.7% 1.7% 1.7% Anti-Bacterials New 1,330 1,370 1,367 1,356 Y-o-Y Growth (%) 3% 0% -1% Previous 1,330 1,344 1,324 1,300 Absolute Change 0 25 43 56 -13% % Change 0.0% 1.9% 3.2% 4.3% Increased ROW sales of old antibiotics Metabolic New 1,514 1,121 1,176 1,275 Assumes Avandia returns to growth in 2009 Y-o-Y Growth (%) -26% 5% 8% Previous 1,514 1,193 1,257 1,359 Absolute Change 0 -72 -81 -83 24% % Change 0.0% -6.0% -6.4% -6.1% Avandia ex-US sales trimmed based on YTD performance so far Vaccines New 1,993 2,355 2,855 3,290 Significant new Vaccine launches including Cervarix, Rotarix and Synflorix Y-o-Y Growth (%) 18% 21% 15% Previous 1,993 2,395 2,971 3,394 Absolute Change 0 -39 -116 -104 34% % Change 0.0% -1.6% -3.9% -3.1% Cervarix US launch pushed out to 2010 Oncology and Emesis New 477 472 564 740 Slow growth of Tykerb and plus the launch of Promacta and HuMax CD20 Y-o-Y Growth (%) -1% 19% 31% Previous 477 471 567 747 Absolute Change 0 1 -2 -7 1% % Change 0.0% 0.3% -0.4% -0.9% Cardiovascular and Urogenital New 1,554 1,728 1,864 2,021 Significant Lovaza Growth Y-o-Y Growth (%) 11% 8% 8% Previous 1,554 1,820 1,929 2,089 Absolute Change 0 -92 -65 -68 19% Coreg, Arixtra and other CV trimmed based on YTD performance % Change 0.0% -5.0% -3.4% -3.2% Other New 957 920 855 835 Y-o-Y Growth (%) -4% -7% -2% Previous 957 998 981 971 Absolute Change 0 -78 -126 -136 37% Cut to reflect disposal of tail products % Change 0.0% -7.8% -12.9% -14.0% Total Pharma Sales New 19,233 19,198 18,669 19,372 Y-o-Y Growth (%) 0% -3% 4% Previous 19,233 19,273 19,099 19,788 Absolute Change 0 -75 -430 -416 125% % Change 0.0% -0.4% -2.3% -2.1% Source: JPMorgan estimates, Company data.

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Europe Equity Research 24 July 2008

Alexandra Hauber (44-20) 7742-6655 / (1-312) 325-3694 alexandra.m.hauber@jpmorgan.com

Table 6: Sales Forecast Changes (£m, unless otherwise stated) 2007E 2008E 2009E 2010E Contrib to

09E Chg Comments

Consumer Health New 3,483 3,780 3,938 4,094 Y-o-Y Growth (%) 9% 4% 4% Previous 3,483 3,680 3,851 4,008 Absolute Change 0 100 87 86 -25% Growth in Oral Care and Nutrition offset Cuts to alli forecast % Change 0.0% 2.7% 2.3% 2.2% Total Group Sales New 22,716 22,977 22,607 23,465 Y-o-Y Growth (%) 1% -2% 4% Previous 22,716 22,952 22,950 23,795 Absolute Change 0 25 -343 -330 100% % Change 0.0% 0.1% -1.5% -1.4% Source: JPMorgan estimates, Company data.

Our new estimates are 6% below the pre-results consensus for 2009 &2010, and 9% and 13% for 2011 and 2012, respectively.

Investment Thesis On our new estimates, GSK is now trading on 12.2x times ’09 business performance EPS, almost in-line with Roche at 12.9x times. Investors should sell into the recent sector rotation based strength – particularly now with reduced buying activity from GSK in coming months to support the share price.

Apart from negative earnings momentum, (as we expect consensus earnings to come down) there is no major catalyst on the horizon until 3Q’08 results, when GSK may provide the first ‘official’ company outlook into 2009.

The Promacta PDUFA is on Sept 19, which may turn out as a small negative,, as - based on FDA body language on May 29 Advisory meeting - we expect a delay to 2009 until long-term data is available.