GLAXF - GSK - Greenshoots In The Horizon

2023-12-13 12:51:53 ET

Summary

• GSK's diversified portfolio and high dividend yield make it an attractive option for conservative value portfolios.
• The company's pipeline of drugs is improving, with a significant increase in drugs in clinical development and strong financial results.
• GSK's valuation is lower than its peers, but its share price has remained stagnant despite positive financial growth.

I have long favoured GSK plc ( OTCPK:GLAXF , GSK ) over many of its peers due to what was a uniquely diversified portfolio of business that GSK possessed versus other pharma majors. Warren Buffett had a similar view many years ago when he made a small investment in GSK. My view was always that patented prescription medicines provided high growth and fat profitability margins, but the downside was cyclical volatility with patent expiries, while vaccines and consumer healthcare provided an anchor of stable revenues but with the downside of low profit margins. For a conservative value portfolio, I thought GSK was a perfect fit. The sector-beating dividend yield was another major attraction.

I was not keen on GSK's executed plans to spin off and dilute its stake in its consumer goods business. I thought then that GSK's investors would be losing out on an important anchoring asset that differentiated it from other pharma majors. But what do I know - GSK's CEO Emma Walmsley would definitely know better.

But why did GSK's fortunes (and the fortunes of its investors) fare much worse than many of its peers?

It's all about the pipeline…

GSK has suffered for years from a mediocre pipeline of blockbuster drugs. The spinoff of the consumer healthcare business last year was intended to help focus GSK's resources on the drugs business. GSK does seem to be on the right track; pharmaceutical sales jumped in 2022 to GBP 21.4 billion in 2022 from GBP 17 billion in 2021, and total sales are expected to jump by another 12-13% this year - having been raised throughout the year from mid-year estimates of 8-10%. Estimates for Adjusted EPS growth of 17-20% are even juicer and do start to give the impression to investors that GSK's share price might be undervalued. The growth levels of 2023 and 2022 rival (finally) those of high growth pharma peers.

Today, GSK has 67 drugs in clinical development - 27 of which are between late stage 2 and between imminent regulatory approvals. This is progressively increased from a pipeline of 64 drugs - 21 of which are in pivotal studies - at the end of Q1. In Q1 2022, GSK had a pipeline of 59 vaccines and medicines. GSK boasts that it grew the, traditionally timid, vaccines division by 21% in Q3 2023 versus a year earlier and specialty medicines by 14%, while GBP 7.8 billion have been generated to date from new drugs that have been launched since 2017. Progression and the upward trajectory are undeniable.

Financial results are consistently strong

In the latest Q3 financial results published last month, GSK delivered impressive results with sales growing by 16% (excluding COVID drugs), Adjusted Operating Profit by 22%, and Adjusted EPS by 25%. Margin expansion continued strongly, with Gross Profit Margin expanding by 3% from Q3 2022 to 74%, and Operating Profit Margin growing from 33% to 34%. Free Cash Flow dropped by a billion to GBP 1.4 billion, mainly due to higher working capital outflows, explained by the company to be due to high accounts receivables related to a new launch that should be collected by Q4 2023. Net debt decreased by a billion to GBP 17.5 billion, giving GSK a comfortable level of less than 2x Net Debt to Operating Cash Flow. This is likely to continue supporting GSK's Stable A credit rating - higher than the historical BBB+ that was assigned to it - and providing GSK with plenty of financial flexibility to increase investment, and to make acquisitions when and if it finds the right opportunities.

Valuation is attractive, dividend needs to be beefed up

GSK has been valued below peers for years now, and its share price has barely budged over the past five years. While the share price of main UK peer AstraZeneca has risen by more than 120% over the past five years, the share price of GSK has barely moved. As a result, AstraZeneca's market cap is now 2.5 times larger than GSK while GSK used always to overshadow AstraZeneca. AstraZeneca is valued at around 33x P/E versus GSK's 11x.

GSK is still in the doghouse in terms of valuation, and its share price as I write this article is almost exactly where it was at the beginning of the year. This is despite strong financial growth in each set of financial results that were published this year. Having said that; US rival Pfizer is witnessing a downward spiral in its share price; falling by 44% over the past 12 months, after its groundbreaking COVID vaccines became no longer in demand. GSK has maintained a middle ground in terms of investor returns.

With the risk of crippling litigation from Zantac now largely behind us, I see no major downside risks that could dip GSK's share prices deeper. GSK's dividend yield of 3.8% is less impressive than past levels of 6% - especially in a 5%+ interest rate environment - but it is not bad for a growing business, and can help boost attractive shareholder returns.

Haleon's listing was unfortunate - to say the least

It has been 18 months since the demerger of the consumer healthcare business, Haleon, and it is more and more obvious that GSK's leadership made a misguided decision by rejecting Unilever's early 2022 bid of GBP 50 billion (fortunate for Unilever's investors). Haleon never got close to the GBP 50 billion mark since it became a public company in the summer of 2022, leaving GSK's, and now Haleon's, investors with two years - and probably many more years to come - of significantly, and unjustifiably, lost returns. Hindsight is a beautiful thing, true, but even in early 2022, it was difficult for GSK's leadership to make a convincing case of why they rejected Unilever's bid. Arrogance is the definite reason, as publicly stated expectations of phenomenal returns as a stand-alone business were not convincing even to the most amateur of investors. The handling of this saga is a definite black spot in the record of GSK's leadership team. But, hey, no one is perfect, right?

But, aside from missing out on GBP 10 billion or more of lost cash for shareholders, GSK's leadership has been steering GSK into a favourable operational and financial direction, and, with a low valuation and high dividend yield, GSK is certainly worth having a seat at the table in an investor's diversified portfolio.

For further details see: