- GlaxoSmithKline is a British, international pharma company formed in early 2000, and was the world's sixth-largest pharma company as of 2019.
- It is the fourth largest stock on the London Stock Exchange, but holds the dubious honor of agreeing to pay the largest settlement by a drug company ever following the fraud.
- Under the hood, we have a fundamentally appealing company, but there are certain considerations that we need to be aware of before we start investing in the business.
- Because of the uncertainties here, I am choosing superior and safer investments at this time. GSK might be more interesting in the future.
This is going to be an interesting article. Few companies that I haven't written about have received as many requests as GlaxoSmithKline (NYSE:GSK). Despite me having a large portfolio focused on international stocks, GSK is as of this time not part of that portfolio. Not even a small, watchlist position. I have zero shares in the company.
In this article, I aim to explain why that is, and what could cause me to change my perspective on GSK, while also explaining what we could be expecting from the company.
GlaxoSmithKline - What does the company do?
GlaxoSmithKline is a pharmaceutical company active in three key areas and segments, which also happen to form its operational segments. This is a massive company with annual sales revenues of over £34B as of FY20, half of which comes from what today is known as the "Pharma" segment.
The above split means that the company is fairly well-diversified as it is, with products in its portfolio including Advil, Voltaren, and Panadol in pain relief, as well as other key products which are staples in European (and international) homes. The company's consumer staples segment is an impressive part of the business - and we'll get back to this going forward.
GSK also has brands like Nicotinell, Nicorette, Tums, Centrum, and many other appealing consumer-segment brands.
When it comes to pharma, GSK is active in areas such as asthma, cancer, infections, diabetes, and mental health. The current company pipeline of coming and planned products and drugs is impressive.
The company guides for 10 "potential" blockbuster launches by 2026, with several coming in 2021-2022. GSK has a high-value oncology portfolio, medicines targeting multiple myeloma, and is a bit of a world leader in the area of infectious diseases - both in terms of vaccines and medicines. GSK has plenty of skeletons in its closet, including things like Avandia (false claims about a diabetes drug), Paxil/Seroxat which was marketed to under-18s for treating depression, the Pandemrix/Narcolepsy scandal, which was specific to Scandinavia among other areas, and hit extremely close to home.
Some scandals and issues are bound to occur when it comes to companies such as these - but GSK has certainly seen its fair share since the early 2000s.
The company's focus on respiratory, HIV, Immuno-inflammation, and oncology is likely to continue as the company continues to focus on immunology, human genetics, and other advanced technologies. The company owns part of ViiV Healthcare, a global specialist company with Pfizer (NYSE:PFE) and Shionogi as shareholders, through which it manages regulatory approvals and launches of HIV-related medicines.
In terms of established medicines and brands, GSK has nearly 100 of them, spread through areas like anti-infectives, allergy, diabetes, central nervous system, dermatology, respiratory, and urology.
GSK is also the first company in the world to apply for regulatory approval for a malaria vaccine back in 2014. As of today, the pilot vaccination project for the vaccinations using this vaccine, named RTS, S/AS01, or Mosquirix, is launched in Malawi, Ghana, and Kenya. If successful, GSK would be the first company in the world to have delivered a vaccine for malaria. This is only part of the company's vaccine portfolio.
GSK is the largest vaccine company in the world in terms of revenue, and currently has over 20 vaccines with another 17 in the pipeline. The latest major release was the Shingles vaccine Shingrix, which received approval in the US and Canada. In 2020, GSK sold more than 582 million doses of vaccines across the world. The company's vaccines target diseases like:
- Pneumococcal disease
- Whooping Cough
Of course, the company also has a COVID-19 vaccine under development.
Fundamentals for the company aren't bad. You're looking at a fairly excellent dividend coverage of around 75% EPS in terms of payout, and a 22-year dividend streak without interruption - although also one without growth. Margins are fairly good at around 25% in terms of operating margins, and 16% RoIC and 33% RoE. Debt really isn't an issue here at around 2.29X Net Debt/EBITDA and the company covers interest costs at nearly 10X - so no worries here.
The challenges come when we start looking at where the company has gone for the past 10 years. I don't want to say "nowhere", but...
... it doesn't take advanced math to see that this is not an appealing trend. FCF shows similar lag. The fact is that fundamentally speaking, and looking at GSK as an investment, if you had invested at 15-16X P/E in 2001, you'd have made around 3% returns annually until today, including dividends.
This is a very poor track record, and it reflects what we see in earnings above. The company has simply averaged a very sub-par rate of growth, both in terms of EPS and revenues.
The company may be, and is, a business with some extremely appealing brands in its portfolio, but there's something wrong with this company at its very core that it can't take the massively successful brands and turn this into earnings and positive returns for shareholders.
Let's look at recent trends.
GlaxoSmithKline - How has the company been doing?
Overall, 2020 wasn't bad, considering we were in COVID-19, and GSK wasn't the quickest out of the gate with a COVID-19 vaccine. The company delivered a turnover of £34.1B, with around £7.8B in operating profit, which is up between 12% and 15% YoY, and around 23-26% EPS growth (in terms of total earnings per share, down 2% in GAAP or -4-6% in adj. EPS).
GSK saw 9 major approvals during the year. However, out of all segments of its business, only Consumer Healthcare actually saw any sort of growth during the year. The company's pharma and vaccine segments underperformed due to COVID-19.
That's not to say every part of these segments underperformed as there was growth in HIV, Respiratory, Oncology, and other portions, but Consumer Healthcare continued to be the star of the show here. Like other companies, GSK has focused on improving its digital capabilities during this pandemic. The company has also raised around £1B in cash through selling non-core items from its consumer healthcare portfolio.
The biggest news, and what I want to spend large parts of this segment talking about, is the proposed and planned splitting of the company into two parts.
The first will be the "New GSK", a large biopharma company that focuses on immune system science, genetics and advanced technology. It will house what is now pharmaceuticals and vaccinations.
The second is the new Consumer Healthcare company, which naturally will house all of the products currently found in the Consumer segment.
Splitting up the sixth-largest pharma company in the world is of course no small feat. Separating 30% of company sales from its business will mean that what remains in GSK will likely be unable to cover the company dividend at its current level. That's why GSK has already said that it will reduce its dividend in early 2022 when this split is expected to occur.
More specifics about these plans will come during investor updates slated for June - however, we know a few more things from investor presentations and earnings calls.
First off, the company's consumer business will have an EPS payout of between 30% and 50%. While we have this, we don't yet know how GSK will structure how the separation is done. We don't yet know if the new company will be spun off as shares to shareholders. GSK could also decide simply to IPO its consumer division, thereby returning some of the earnings to shareholders as cash.
30% of company earnings would indicate EPS of around $0.3/current share, which would mean $0.09-$0.15 in dividends from such a company. We don't yet have yield numbers or similar data.
GSK's core problem for years has been rather straightforward. The company has failed time and time again to, through R&D CapEx, deliver new medications/products that could really catapult earnings and deliver returns for shareholders. This failure is evident from earnings and numbers, and any success the company has had has been insufficient to offset the drop-off from legacy products losing patent protection. This is the way of the pharma industry, the way the "game" is played there. You need to constantly innovate to replace existing drugs with new ones in order to keep growth high.
This is exactly what GSK has failed to do, with 2020 generating less pharma revenue than 2013.
Yes, the company's yield is appealing, at least on the face of it. But this comes with the caveat that for a long time, that yield is almost the only thing that shareholders have been receiving, all the while the market outperforming the company both short- and long-term.
The spinning off of the consumer segment could result in more retained cash being put into R&D and building the company's drug portfolio. However, this assumes that what GSK is facing is a cash problem, not a management and structural one. This sort of long-term outperformance for a company with these fundamentals always has me a bit dubious. It's not as though GSK doesn't have access to the credit markets, or to cash, if the R&D/pharma problem was one the company could simply "throw money at" to solve.
The fact is that there are plenty of indicators that management is a key part of the issue at GlaxoSmithKline. There have been flights from R&D for some time, with Patrick Vallance being the last to leave after around 6 years. This is not to say that Vallance has been a star, but the sort of complete and thorough shake-ups that have been done in GSK isn't done for positive reasons.
GlaxoSmithKline has the 11th largest R&D budget at $4.5B. That's $4,500,000,000. The company has very little to show for it in terms of pharmaceuticals, where I'm talking about clear blockbuster importance/indicators. It's difficult for an outsider to say whether the problem is within R&D, or with management itself - but it seems obvious that failure to generate meaningful returns or potentials from this sort of capital has some serious underlying indicators.
While spinning off consumer health will certainly allow the company to focus in a different way, will it be enough?
There are positives. GSK has a very well-diversified portfolio. Even following the split, no company drug will amount for more than 10% of sales, with revenues spread out across a multitude of therapeutic areas. The consumer segment, meanwhile, is an absolute blockbuster in terms of what brands they have and is likely to generate stable earnings for years and years to come.
However, a company having great legacy brands and legacy products isn't enough to indicate future outperformance. While currently, analysts do expect some great things out of GSK, there is plenty of uncertainty to be had here.
Let's look at the company's valuation
GlaxoSmithKline - What is the valuation?
So, let's establish a rule. Virtually any good business, at the right valuation, is essentially a "BUY". That means that at valuation X, where X is an appealing undervaluation in my view, GSK becomes appealing on the basis of simple reversion to a conservative mean, even if the company's growth prospects can be considered uncertain, poor, or worse.
So, with that said, we find GSK trading at a valuation of around 12 to 2020-2021 earnings to P/E. The expectation for 2021 is an EPS drop of a few percent, only to in 2022 and 2023 increase this in the high-single or low-double digits. Including the drop in 2021E, the company's growth rate is expected to be around 4% on a 3-4 year basis on average, which isn't all that impressive. However, the company is also trading at a significant discount for a conservative pharma/consumer healthcare company with a 5.5% yield.
While this yield is subject to change, there's no denying that there's a potential upside to be had here.
Source: F.A.S.T. Graphs
The company is A-rated and with some fairly acceptable debt numbers, and comes in at an upside of around 12% on a 3-year basis, based on FactSet EPS forecasts and a 13.4X historical discount rate based on a growth rate of 3-5% average annually.
This is good in this market, but it's not a "stop-the-presses!" sort of valuation when considering the historical uncertainty we're talking about. What uncertainty, you ask?
Well, for one, GSK's longer-term returns have been abysmal.
On a 10-year basis, you've been losing money at a rate of -5% annually since 2011, and -2.1% since 2001 excluding dividends. Even including the company's generous dividends, you're barely positive at 1.5% annualized since 2001. This is very poor.
While it's technically possible to catch this company at undervaluation, even the most bottom sort of valuation compared to today's valuation would have generated sub-par returns when comparing to the market overall.
The simple fact is that GSK has been performing very poorly, essentially sideways for almost 2 decades, and people who invested their hard-earned capital into the company's common share have been stifled of good returns when comparing to the overall market.
As we've seen above, GSK's issues are structural. This does not seem a question of temporary underperformance or headwinds. The signals coming out of London indicate that there are some real problems in the company's R&D department, and the management shake-up, while potentially positive news, is no guarantee for any sort of fundamental change.
I'm extremely hesitant investing in companies like this, companies that have proven over long periods of time, that they essentially go nowhere. It's not as though the market has improved for GSK for the past 10-15 years, since the company's last EPS growth spurt.
The opposite in fact. Some of the company's products are facing patent expiration, and new entrants are fighting for market share against the company's consumer products. I'm not saying they will succeed - I'm saying they exist, and they need to be considered.
Some people really believe literally in the phrase that "past performance is no indicator of future performance". While at heart this is a good stance to have, I do believe that company with a history of outperforming the market has a tendency to do so in the future as well.
More importantly, though, I don't see companies that for a 20-year period have underperformed the market suddenly start outperforming the market, especially not based on something like splitting the company apart with an axe. It may indeed work to simplify operations for the company, and it may serve to bring back some focus to R&D - but of what value will that be to shareholders in the short, medium, and long terms?
I do believe that there's potential for reversal here, at least some of it, beyond 2021. However, results this year are set to be negative, and there's a risk here that we're headed lower for GSK. A 12X P/E valuation on an average weighted basis is historically not a valuation that's resulted in any sort of appealing performance, and with the unknowns of the dividend and how the company intends to handle the split, I view GSK as an "unsafe" investment.
Current analysts from S&P Global give GSK the following price targets.
Source: Google Sheets, S&P Global
These targets mirror the targets for the native, GBP listing. Analysts have a history of assigning a very high price target to this stock, essentially valuing it at 15X P/E or above despite the company's historical poor EPS growth rate. It smells of analysts hoping for a turnaround in an otherwise great company.
On that part, I'm in agreement. I too hope for a turnaround here, and should GSK normalize and manage to deliver EPS growth thanks to an appealing split-up in combination with an R&D and pharma turnaround, GSK should be on every dividend investor's shortlist.
However, at current valuations, I don't see the upside for the company warranting such a positive view, or such positive targets, because there are not enough indications that such changes would be likely. What we have are hopes, and company promises, which of course need to be taken with a mountain of salt, given this company's historical performance.
Let's look at the investment indicators. Remember, this is what I believe every single one of your investments should be based upon.
1. This company is overall qualitative.
2. This company is fundamentally safe/conservative & well-run.
3. This company pays a well-covered dividend.
4. This company is currently cheap.
5. This company has realistic upside based on earnings growth or multiple expansion/reversion.
GSK does check an impressive number of boxes, at least in theory. There is, however, uncertainty, on how well this company is run, and what the realistic upside looks like, which brings into question if the company is cheap or not. Looking at the history, GSK has dropped as low as 9-10X P/E at times of negative earnings growth, which is what we're looking at.
If we consider this indicative, we should assign GSK a price target of around $25-30/share based on a 9-10X 2021E EPS multiple, which would indicate an overvaluation in the double digits here.
My key reason here is also the alternative investment argument. There are still companies that offer better upsides with far better security than this company does.
I wouldn't say GSK is uninvestable or a bad company. It isn't. It's an interesting, conservative business with a potential upside over the long term. The key problem is the "potential" part because, from a historical point of view, GSK's visibility for earnings and the effect upon valuation even in the long term is very dubious.
The fact that we're also facing a split-up scenario increases the uncertainty here, as well as an already-announced dividend cut. Any investment into GSK here is made with limited knowledge and visibility.
I don't like that sort of investing - the risk/reward factor skews too strongly towards "risk" for my liking.
For a company with this poor an EPS growth history, no matter how conservative and positive parts of their portfolio are, I'm happy to wait until there's greater visibility.
However, should the company drop to levels of around $25-$30/share, color me interested and potentially revisiting the thesis here.
For now, though, I'm still out. Color me a "HOLD" here. I believe you're better off investing in more conservative companies with higher, historically-based upsides that generate positive returns for the next few years.
Thank you for reading.
This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.
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