GlaxoSmithKline's Results Down - Dividends Up

|
 |  About: GlaxoSmithKline (GSK)
by: Steven Dotsch

Blaming, in particular, lower demand for vaccines and Europe's spending cuts in health care budgets, UK's pharmaceuticals giant GlaxoSmithKline (NYSE:GSK) released third quarter sales down 8 percent to £6.5bn (US$10.4bn), while net profits fell 18.5 percent from a year earlier to £1.12bn (US$1.8bn).

Until July, GSK had been predicting a return to sales growth this year. While the company missed sales and earnings expectations in the third quarter, Sir Andrew Witty, chief executive of GSK, still expects to see sales growth in the fourth quarter, with overall sales for the year coming broadly into line with 2011. (That is assuming there is no further deterioration in Europe!)

Spending cuts in Europe are clearly hurting

Increasingly GSK appears to suffer from the same Eurozone 'macro' issues as other pharmaceutical companies - several European governments have cut medicine prices by 7 per cent over the quarter, after an unprecedented 8 percent fall in the second quarter.

National healthcare budgets were not only cut in countries such as Spain, Portugal, Italy and Greece but it is also becoming increasingly difficult getting medicines reimbursed. While other countries, such as Germany, Greece and the UK have taken the opportunity to impose price cuts on drug companies.

Commenting on the spending cuts in European health care budgets, Sir Andrew said that the group faced increased "difficulty" getting new medicines paid for by "many countries". Some new drugs in Europe have even attracted no payment due to "heavy restrictions".

With GSK's European revenues down by 9 percent to £1.71bn (US$2.75bn) in the third quarter, and to counter continued pressure on drug prices at Europe's public hospitals GSK also announced a review of its European operations, which could lead to significant job cuts and redeployment of CAPEX. Results of the review are likely to be announced in three months' time.

"It is clear that the European market is facing a prolonged period of significant economic pressure. In this context we are reviewing our current business and assessing how best to respond to this environment and meet the increasingly diverse needs of European governments," Sir Andrew revealed.

"We're really looking at the whole business in the context of what we believe is quite a changed environment," Sir Andrew said. "We're taking the chance to reassess whether we've got the right resource focus in the right areas." Adding: "I'm struggling to imagine a world where Europe gets easy."

While Sir Andrew declined to give any details on what impact the review would have on staff numbers - insisting it could mean the business hires more people in Europe (read the UK) - analysts raised fears that the move signaled "downsizing". The group currently employs some 38,500 people across Europe.

In the USA, the increasing encroachment of companies providing generic versions of GSK's more expensive medicines, plus the discontinuation of certain products, contributed to a 6 percent decline in the top line sales.

GSK's poor European and US sales were somewhat offset by growth elsewhere in particular from emerging markets, Asia and Pacific countries with revenues up by 10 percent to £1.74bn (US$2.8bn).

"We continue to make progress on our strategy, particularly through increasing our sales exposure to growth businesses, notably emerging markets, and delivering a step-change in output from research and development".

(see the results announcement linked to above)

GSK past its patent cliff?

The pharmaceutical industry's patent cliff looms large for many pharmaceutical companies, the next few years, with sales falling substantially once patents of previous blockbuster drugs expire and generic - lower-priced - drugs replace them.

Some drug companies have more options to handle this than others, including growth in emerging markets, acquisitions, cost management, diversification and in some cases new blockbuster launches.

GSK, like its competitors, has suffered from seeing a series of drug patents expire in recent years, even though it has come through its patent cliff somewhat earlier than some of the other European pharma groups such as AstraZeneca (NYSE:AZN), Sanofi (NYSE:SNY) and Novartis (NYSE:NVS) with the launch of several new products this year and a pipeline of 15 further product launches planned over the next few years.

Of all the European drug companies, GSK, together with Novartis, has the broadest and most diversified pipeline in the sector.

In conclusion

Adjusting for legal settlements, net cash inflow from operating activities was £1.8bn (US$2.89bn) during the quarter. Some £1.9bn (US$3.05bn) of shares have already been repurchased in the year to date and the group, in comparison to AZN stopping further share buybacks, still expects to continue with share repurchases this year.

GSK remains committed to its policy of returning cash via a "growing dividend", balanced with share buybacks (and bolt-on acquisitions where returns are more attractive). The first two quarters of 2012 have both delivered DPS growth of 6 percent on the 2011 comparators.

The third quarter is no different with an improvement on last year's third quarter pay-out of 17p, the dividend has been increased to 18 pence.

"In conclusion, our focus is to continue to deliver on our strategy to maximise growth opportunities and actively prepare for the roll-out of multiple new products. We remain confident that these new products, combined with our strengthened businesses in emerging markets and consumer healthcare and further execution of our financial strategy, provide GlaxoSmithKline with clear opportunities to deliver sustained improvement in long-term financial performance and overall returns to shareholders," Sir Andrew said.

Disclosure: I am long GSK, AZN. 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.

Additional disclosure: Our Dividend Income Portfolio is a long term shareholder in GSK. At current share price levels, GSK shares are trading between their historically undervalued and overvalued levels as per our valuation methodology.