It’s delivered consistent income but long-term growth investors have been disappointed. Analyst Edmond Jackson explains why he rates this famous company a ‘buy’.
Healthcare is a potential source of stalwart stocks due to an ageing population and the likelihood that democratic governments will try to placate voters by at least maintaining health spending.
I have favoured AstraZeneca (LSE:AZN) for its successful research and development on harder-to-treat cancers, its stock enjoying a bull run especially from 2013 after Pascal Soriot became CEO in August 2012. Its £176 billion market value nowadays greatly exceeds £59 billion for GSK (LSE:GSK), which despite retaining FTSE 100 status has been stuck in a volatile-sideways range for the last 20 years.
There is irony in the way “Glaxo” used to be London’s bellwether pharma stock, and also in the way AstraZeneca originated as a 1999 merger and made vigorous acquisitions, only by 2012 to be in need of a fresh start. AstraZeneca shows how a capable CEO can make a difference: R&D levels became among the highest in the industry and the group nowadays enjoys a reputation for mass market drugs.
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Emma Walmsley took GSK’s helm in April 2017 having joined in May 2010 from L’Oreal with a consumer marketing background. While she is not a scientist, Soriot began his career in pharmaceutical sales in the 1980’s before assuming operational management roles.
After initially leading the European consumer healthcare side, she became CEO of consumer healthcare – representing around a quarter of GSK’s revenues.
Soon after becoming group CEO, she declared a priority for developing and commercialising new drugs, with some 80% of R&D capital focused on a maximum four disease areas.
Recent operating results show HIV, shingles, respiratory and pandemic as key drivers, if hard to guess future winners, in a context of R&D running at around 16% of revenue.
The financial summary table below shows somewhat erratic performance - especially earnings per share (EPS) from 2016, by which time the effects of a new CEO ought to have manifested. In fairness, AstraZeneca’s EPS declined from 2016 to 2018.
GSK - financial summary
Year-end 31 Dec
|Turnover (£ million)||27,889||30,186||30,821||33,754||34,099||34,114|
|Operating margin (%)||9.3||13.9||17.8||20.6||22.8||18.1|
|Operating profit (£m)||2,598||4,181||5,486||6,961||7,783||6,165|
|Net profit (£m)||912.0||1,532.0||3,623||4,645||5,749||4,385|
|EPS - reported (p)||23.3||66.0||88.0||116||143||108|
|EPS - normalised (p)||40.9||118||107||169||122||109|
|Operating cashflow/share (p)||165||175||212||200||209||196|
|Capital expenditure/share (p)||59.9||55.7||45.2||53.9||55.6||72.3|
|Free cashflow/share (p)||105||119||167||146||153||124|
|Dividends per share (p)||80.0||80.0||80.0||80.0||80.0||80.0|
|Covered by earnings (x)||0.5||1.5||1.3||2.1||1.5||1.4|
|Return on total capital (%)||6.5||14.0||15.4||12.5||13.4||11.1|
|Net debt (£m)||13,804||13,178||22,106||25,722||20,780||19,838|
|Net assets (£m)||1,124||-68.0||4,360||11,405||14,587||15,055|
|Net assets per share (p)||28.6||-1.7||111||288||363||374|
Source: historic company REFS and company accounts
GSK enjoys a strong operating margin in high-teen percentages, aiding robust free cash flow. Capital expenditure – substantially R&D – has taken around a quarter of operating cash flow, although AstraZeneca’s success was probably helped by capital expenditure absorbing over 30% of cash flow – it was 83% in 2019 after 52% in 2018.
Insufficient foundations for growth may part-explain the long-term sideways’ stock trend. The board appeared to prioritise maintaining an 80p dividend after the payout grew from 36p a share in 1999 to 100p in respect of 2015. But this meant for example in 2016 that normalised earnings cover was only 0.5x.
How then, is the CEO addressing this lack of clear identity for growth or income?
Demerger of the consumer healthcare side
A key initiative last July was to create Haleon (LSE:HLN) as a separate £30 billion listed company, making popular products such as Panadol painkillers and Sensodyne toothpaste.
Aims were to help achieve higher sales and profit at both companies, and focus GSK on three divisions: vaccines, specialty medicines (such as cancer treatments) and general medicines (such as asthma inhalers).
Terms were one new Haleon share for each GSK held, with GSK retaining 14% of the company and Pfizer Inc (NYSE:PFE) owning 32% - albeit both holders intended to sell down their stakes. Creating such an “overhang” appeared perverse stock marketing – at least in the short term – and unsurprisingly Haleon fell from around 310p to below 250p by early September.
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Haleon has, however, recovered to achieve a 327p high where, if consensus forecasts are fair, it trades on 17x expected EPS of around 19p for 2022, although growth is expected to consolidate in 2023. Meanwhile, it is targeted to pay a 3.3p total dividend in respect of 2022 and 6.5p for 2023, hence a low-single-digit yield.
While supported by net assets of around 290p a share, it appears to continue GSK’s trait of no special appeal either for growth or income. Pricing currently looks fair, hence a “hold” for GSK investors who obtained it.
A ‘new progressive’ dividend policy?
GSK has said it targets gradual growth, paying out 40-60% of earnings, averaged across investment cycles.
Yet the board has lowered the start base, guiding for a 56.25p dividend for 2023 which equates to a 3.9% yield at GSK’s current stock price of around 1,440p. This would be covered 2.4x by consensus for normalised EPS of 135p based on £5.4 billion net profit.
If such an outlook is fair, this yield is interesting given healthcare returns should be relatively reliable.
Sound growth and a seemingly attractive pipeline
The last trading update in early November anticipated 8-10% annual sales growth and 14% to 16% earnings growth – this resulting in a consensus for 2022 EPS around 135p.
Third-quarter revenue rose 18% to £7.8 billion, or by 9% at constant exchange rates. Over nine months these rates were 25% and 19% respectively, hence some slowing in growth lately.
Adjusted third-quarter EPS leapt 25% to 46.9p, or by 11% at constant currency, versus 31% and 20% respectively over nine months.
“Notwithstanding uncertain economic conditions...we continue to see evidence of healthcare systems recovering...” the company said.
Consensus for 2023 EPS of 145p implies a forward price/earnings (PE) ratio of 10.6x, but if recent momentum is sustained then the PE would be in single figures.
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The operations narrative was encouraging, highlighting strong growth in speciality medicines, record sales for Shingrix (anti-Shingles) whose global expansion is expected to “drive” 2023 performance – which can sound a bit like reliance on one product.
Yet the late-stage R&D pipeline has improved, with regulatory approvals for Boostrix maternal (anti-diphtheria, tetanus) and Menveo single-vial presentation (against bacterial disease).
GSK says: “The early stage pipeline is being strengthened and there will be ongoing investment in targeted business development in support of growth.”
Third-quarter continuing operations generated £1.9 billion cash enabling £0.7 billion free cash flow, with a 7% reduction in net debt to £18.4 billion from end-2021.
Mind how a circa £20 billion reduction in non-current assets – possibly the demerger – has brought GSK’s net equity down to £8.7 billion. That implies net gearing of 211%, although net finance costs took only 14% of operating profit during the third quarter.
The crux question – whether risk/reward tilts positively at the current 1,440p stock price – therefore involves quite a leap of faith; that GSK’s drugs’ delivery can become more vigorous.
Overhang of cancer risk liabilities removed
Earlier last month, a US multi-district court rejected 2,500 lawsuits claiming GSK’s heartburn drug Zantac caused cancer. The court ruled the scientific consensus shows no consistent or reliable evidence of raised cancer risk.
The stock leapt 7% from around 1,400p but has lost most of that, as if fears of as much as £37 billion equivalent compensation becoming due has not actually been the drag.
I stall at GSK being a conviction “buy” because speculation is involved as to drugs development and US lawmakers could toy with price controls to check people’s cost of living.
Yet its pipeline appears strong and the modest PE plus material yield reflect weak sentiment. GSK therefore rates a contrarian pick: Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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