GlaxoSmithKline: Why This Drug Manufacturer Belongs In Everybody's Portfolio

Oct.18.13 | About: GlaxoSmithKline (GSK)

I have been looking at U.S. and European large-cap drug manufacturers recently in order to add some undervalued companies to my long-term income portfolio. Drug manufacturing companies are particularly suitable for income-driven strategies: They often pay 3-4% dividend yields while providing investors with upside potential when new blockbuster products receive regulatory approval and lift company sales.

Share performance

GlaxoSmithKline (NYSE:GSK) has returned 43% over the last five years and is the worst performing drug company in the peer group. Bristol-Myers Squibb (NYSE:BMY) gained 182%, Sanofi (NYSE:SNY) 82%, Merck & Co. (NYSE:MRK) 72%, Pfizer (NYSE:PFE) 83% and Novartis (NYSE:NVS) 59%. GSK's performance is mediocre and some might say problematic. But problems often are an opportunity in disguise: GSK's strong vaccine pipeline and high cash flow yields make this company an interesting Buy candidate for investors.

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Strong forecasted earnings growth

GSK has a domineering vaccine portfolio that consists of more than 30 vaccines to fight serious diseases such as hepatitis A, hepatitis B, diphtheria, tetanus, whooping cough, measles, mumps, rubella, polio, typhoid, influenza and bacterial meningitis. I expect GSK to deliver future earnings growth predominantly via its vaccine and prescription medicine segments. Late-stage products such as MAGE-A3 to treat melanoma and non-small cell lung cancer could be driving GSK' earnings growth if the company manages to obtain final regulatory approval. Analysts expect the following earnings growth rates for GlaxoSmithKline:

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Valuation

GlaxoSmithKline is one of the cheapest, high-yield large-cap drug manufacturers in the sector and would make a good addition to a diversified dividend portfolio. GSK trades at just 13.07 times forward earnings just marginally higher than Sanofi at 12.74 and Merck & Co. at 13.04. GlaxoSmithKline's low valuation and high dividend yield provide investors with a significant margin of safety and a reliable income stream backed by recurring cash flow.

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Probably the most convincing reason to purchase GlaxoSmithKline is its dividend yield of 4.32% which is top in class. Merck & Co. pays investors 3.65% and is the only other drug manufacturer that exhibits a dividend yield above the peer group average dividend yield of 3.30%.

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I have summarized market capitalization data and valuation metrics for the six largest U.S. and European drug manufacturers in the table below: GlaxoSmithKline currently trades at a 14% discount to the peer group average P/E ratio of 15.14. Its PEG ratio stands at 4.99 and displays a 22% discount to the PEG average of 6.43. GlaxoSmithKline's dividend yield is 31% above the peer group average of 3.30%.

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Summary

GlaxoSmithKline can provide income investors with a decent-sized dividend yield, provide diversification benefits and reduce portfolio volatility. Drug manufacturers often achieve temporary monopolies by patenting their drugs and charging premium prices for them. On average, this practice is very profitable for companies. GlaxoSmithKline has proven with its extensive product portfolio that it can successfully innovate and bring products to market. GSK offers investors a 4.32% dividend yield and exposure to the vaccines business. The company also pursues a share buyback program repurchasing £1-2 billion worth of shares in 2013. GlaxoSmithKline's low multiple increases chances of multiple expansion should GSK be able to deliver blockbuster cancer or malaria drugs. Long-term Buy based on dividend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.