Pharma is not an industry for resting on one’s laurels. Revenues are highly dependent on patent exclusivity, and competition from generics can choke cashflows when research and development pipelines need a boost. For GlaxoSmithKline [GSK] investors, the generics threat is set to hit home this year, after the US Federal Drug Administration approved the first rival product to GSK’s blockbuster asthma treatment Advair. In its February fourth-quarter earnings announcement, the company forecast EPS to fall 5-9% in 2019.
GSK’s share price has been fluctuating wildly over the past twelve months, even more so than the FTSE100 at large. New initiatives announced in recent months suggest CEO Emma Walmsley, who took the helm of the firm in April 2017, is taking radical steps and looking beyond GSK’s walls to bolster investor confidence.
Forecasted EPS reduction in 2019
Making consumer healthcare its own business
On 19 December, GSK announced its consumer healthcare unit – which produces everything from toothpaste to anti-inflammatory gels and nose sprays – would become part of a new joint venture with Pfizer. GSK would hold the majority-controlling share with 68% equity, with Pfizer holding the remaining 32%. The ultimate objective is to demerge the joint venture into its own UK-listed company within three years, with the main GSK entity turning its focus entirely to prescription medicines and vaccines.
The consumer healthcare venture will start out with £9.8bn in annual sales, and will target the US and China for future growth. Estimated savings are put at £500m, annually. When announcing the venture Walmsley emphasised it would not only cement its own position, but also accrue cashflows for GSK, to the benefit of its pharmaceuticals R&D. “The most important thing to understand about this transaction is that it strengthens both businesses and cashflows so that we are better positioned to invest in shareholder returns and growth,” she said.
“The most important thing to understand about this transaction is that it strengthens both businesses and cashflows so that we are better positioned to invest in shareholder returns and growth” - CEO Emma Walmsley
Oncology: the next big thing
GSK is also betting big on oncology research – and in the process, it’s striking alliances with some old-time rivals. Just a day ahead of its full-year results, the company announced it was joining forces with Germany’s Merck to develop and commercialise immunotherapy drug, M7824. That GSK is teaming up with one of its biggest competitors – paying it as much as €3.7bn (£3.1bn), depending on future development results – is testament to how much potential it sees in cancer treatment, and how fast it wants to develop expertise in the space.
|PE ratio (TTM)||21.79|
|Return on equity (TTM)||113.00%|
GSK stock vitals, Yahoo finance, as at 9 April 2019
Meanwhile, in January GSK closed its acquisition of Boston-based Tesaro, which owns Zejula, an oral drug used to treat recurrent ovarian cancer. It was the fourth acquisition in twelve months for GSK, and at £4bn, it did not come cheap. The buyout is expected to weigh on earnings for years, but it gives GSK access to a ready-to-market product – and pipelines – in immuno-oncology, a class of drugs that helps patients’ own immune systems fight tumour cells. It’s a space currently dominated by $7bn-a-year blockbuster drug Keytruda, manufactured by the same rival – Merck – that GSK has partnered with for M7824.
Where does that leave investors?
At just under 1,600p at the start of April, GSK’s share price is not far from analysts’ average price target of 1,644p, as calculated by Yahoo Finance. The stock’s P/E ratio is cheap compared to rivals: 21.96 compared to Merck’s 35.85 and AstraZeneca’s 36.09 – and Morningstar analysts, which hold a 1,790p target, think the stock is undervalued, and may be reaching an “inflection point” as the Advair hit forces a push into HIV oncology and the consumer joint venture.GSK 1-year share price performance, CMC Markets, as at 9 April 2019
Even amid the costly tie-ups and acquisitions, GSK has repeatedly said it would pay an 80p full-year dividend for 2019, as it did for last year. But at least one analyst has questioned whether GSK would be able to sustain this pay-out policy from pharmaceuticals cashflows alone, once consumer healthcare is spun off.
“Losing the steady cash flows of the consumer business means there’s more pressure on the men and women in white coats to deliver the next generation of blockbusters,” wrote Hargreaves Lansdown analysts. “While pharma’s growing at the moment, that’s being driven by a relatively shallow pool of drugs. That’s left the group vulnerable to a towering patent cliff when drug exclusivity expires, and means the expanded and expensive oncology pipeline really needs to deliver.”