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GlaxoSmithKline (GSK - Analyst Report) reported first quarter core earnings of 70 cents per American depositary shares (ADS), up 2% at constant exchange rates (CER), benefiting from ongoing restructuring and cost control initiatives. However, earnings missed the Zacks Consensus Estimate of 72 cents. Investors reacted negatively to the news with the stock falling 1.81%.

On an ex-divestment basis, revenues were down 2% year over year at CER to $9.3 billion. Revenues were below the Zacks Consensus Estimate of $10.2 billion.

All growth rates mentioned below are on a year-on-year basis and at CER.

The Quarter in Detail

The company operates through two segments: Pharmaceuticals and Vaccines and Consumer Healthcare. Pharmaceuticals and Vaccines sales were down 3% while Consumer Healthcare sales remained flat. Pharmaceuticals revenues decreased 4%.  Vaccines revenues grew 3% on the back of strong performances in the U.S. and Europe.

The Pharma and Vaccines segment performed well in Europe (up 3%), Japan (up 13%) and Emerging Markets (up 2%). Segmental sales were disappointing in the U.S. with sales falling 10%.

Sales were affected by de-stocking by wholesalers and retailers in the U.S. and increase in competition for Advair. We note that newly launched Breo sales were lower than expected due to delays in payer coverage. The situation is expected to improve from this month.

Sales in Europe benefited from strong growth in oncology and tender shipments of Rotarix. Revenues in Emerging Markets benefited from favorable vaccine tender phasing of Synflorix. However, ongoing investigation in China continues to cast a shadow on Glaxo.

In the Consumer Healthcare division, sales were negatively impacted by temporary supply interruptions in the U.S. and Europe. Sales increased in the Rest of the World (6%) and decreased in Europe (-4%) and the U.S. (-10%). On a segmental basis, turnover increased in Oral Care (5%) and Nutrition (13%), which was completely offset by a decrease in sales in Total Wellness (-8%) and Skin Health (-4%).

The company bought back shares worth £28 million during the first quarter of 2014. Share repurchases in 2014 are expected in the range of £1–£2 billion.

The company declared an interim dividend of about 64 cents per ADS. The company increased the dividend by approximately 6%.

Recent Development

In Apr 2014, Glaxo announced a major three-part inter-conditional transaction related to its Consumer Healthcare, Vaccines and Oncology businesses with Novartis (NVS - Analyst Report).

As per the terms of the proposed deal, Novartis would acquire Glaxo’s oncology products for $14.5 billion and up to $1.5 billion in milestone payments. In exchange, Glaxo will acquire Novartis’ Vaccines business (excluding influenza vaccines) for $7.1 billion (of which $5.25 billion is upfront and up to $1.8 billion in milestone payments)   along with royalties.

Additionally, the two companies will create a joint venture (JV), thereby combining their consumer divisions to form a larger consumer healthcare business. Glaxo will own a 63.5% share of the JV with majority control. The transaction is expected to be completed by the first half of 2015.

2014 Outlook

Glaxo expects to report revenue growth along with core earnings growth of 4%–8% (both at CER) in 2014 from the year-ago period on an ex-divestment basis. The pre-earnings Zack Consensus Estimate was $3.59 per share for 2014.

Glaxo continues to pursue restructuring and cost-cutting initiatives. The company expects to generate incremental cost savings of approximately £1 billion by 2016.

Our Take

Glaxo’s first quarter results were below expectations with both earnings and revenues missing the Zacks Consensus Estimate. We remain concerned about the challenges faced by the company in the guise of increasing competition and pricing pressure. Additionally, we believe that any strict action enforced by the Chinese government will significantly impact Glaxo’s top line.

However, new products should continue to boost revenues in the coming quarters. We are also pleased with the company’s efforts to control cost and restructure operations. The deal with Novartis is encouraging as well. The transaction is expected to be accretive to earnings. Although bold, we believe that it will strengthen the Vaccines and Consumer segments and can be a potential growth driver for the company.

Glaxo carries a Zacks Rank #3 (Hold). Some better-ranked stocks in the health care sector include Allergan (AGN - Analyst Report) and Johnson & Johnson (JNJ - Analyst Report). Both sport a Zacks Rank #2 (Buy).

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