Before I even begin my argument, I would like to tell you my conclusion: GlaxoSmithKline (NYSE:GSK) looks to outpace this year. They posted an acceptable Q4 last month and tremendous 2006 results. What’s more, GSK expects a strong year ahead and gave a bullish guidance. Of course, challenges still lay ahead for them, most notably stiff competition for Advair and Avandia and patent legal issues. GSK will also see more acquisitions and expansion in the year ahead.
The reason I suggested that their Q4 results were acceptable was because, factually, it missed market expectations. But the lower margins were due to higher-than-expected (and for most, not even expected) restructuring charges and asset impairments – one time issues. Moreover, exchange rates had been a prick in the neck for them, which will continue to hit their EPS in 2007. But, more specifically this is why I think they will perform better this year despite these painful, yet unavoidable, issues:
GSK continued to stand firm on their guidance for 2007, stating that it expects EPS to grow 8%-10% (this was assuming a constant exchange rate). But if exchange rates continued to hold and average out at the current level, EPS will be reduced to a growth of 4%-6%. 5% would be a safe assumption, because with the US economy continuing to head in its current direction, and the Fed’s interest rates decision, exchange rates won’t be improving much for GSK soon.
But on top of that, GSK expects to see “further improvement” in SG&A expenses on a relative percentage to revenue. They are continuing to squeeze firmly on costs. For example, in 2006, R&D charges were 14.4% of sales, and are to be kept stable for 2007. Likewise, restructuring charges for R&D will be much lower this year as well.
Along the lines of revenues, here’s what GSK has in-store – more in 2007 than 2006. Over the last few quarters, GSK has taken the largest price increases in their products, an average of 10%-15% across the board, outpacing all major drug companies in their battlefield. This will definitely help boost 2007 inflows. In their pipe-line, GSK also announced that it has in-licensed two late-stage compounds. XP13512, already in late stage trial, is a drug that that treats restless leg syndrome (a neurological disorder for uncontrollable urges to move the limbs in order to stop uncomfortable, painful or odd sensations in the body) and neuropathic pain, directly competing with Pfizer’s (NYSE:PFE) Neurontin. And Gepiron ER, another drug filed with the FDA to treat major depression and related disorders is currently awaiting the FDA response.
GSK got approval for its drug Alli, an over-the counter obesity drug, which will most likely perform well given society’s growing pressure on weight loss and “staying thin”. Both Advair and Avandia are drugs used to treat asthma and diabetes, which GSK will depend very highly upon for future earnings growth; both face competition in this profitable space – AstraZeneca’s (NYSE:AZN) Symbicort and Novartis’ (NYSE:NVS) Galvus. Last year, Advair faced a slow-down in sales, which was blamed on unusual seasonal weather and lower asthma usage. We’ll have to keep a close eye on the performance of these two drugs.
Also watch out for:
Cervarix – filing with FDA expected sometime in April. This drug treats human papilla virus, a form of skin tumor; if all goes well, results should be visible by 2008.
Tykerb – approved by the FDA earlier this month, this drug that treats breast cancer. This should be available by mid-2007.
Coreg CR – this drug, which treats hypertension, was approved by the FDA last October will be launched later this year. GSK’s management expects that more than 50% of their existing Coreg drug users will convert.
In the end, GSK trades at about 16.5 times its 2006 EPS. (Prices traded at 17 times during 2006 and just over 19 times in 2005). If you push this out to what the market expects for 2007, an EPS of $3.75, and the relevant historical rate, say a conservative 16 times, you should come to a reasonable price of $60.
GSK 1-yr chart
Disclosure: Author has no position in GSK