Why GSK is worth more despite R&D worries

Now that GlaxoSmithKline (GSK) has finally ended investor worries about a dividend-busting M&A deal in consumer healthcare, attention has turned back to what’s wrong with the pharma giant’s R&D pipeline.

CEO Emma Walmsley continues to have this as her number one capital allocation priority, backed up by a number of high profile appointments in recent months.

But as UBS points out in a report today, there’s no reason to let this long-term task cloud the GSK investment case, which it continues to support with a 1600p price target. It points out that as the company gets close to sector average EPS growth, there’s little justification for shares to be trading at a discount.

Referring to the drugs pipeline, they said: “As refreshing as it is to see an honest assessment of the company’s historical R&D shortfalls, fixing these issues is easier said than done and at the very least this will take a long time.”

Instead, UBS highlights its estimate for 5% earnings per share (EPS) improvement between 2017-20, which it says can be driven by “GSK getting the simple things right”.

UBS is focusing on four growth areas, including the potential offered by new shingles vaccine Shingrix and the development of respiratory prospect Trelegy, which is a once-daily single inhaler triple therapy for the treatment of US patients with chronic obstructive pulmonary disease.

There are also opportunities for margin improvements in consumer healthcare, alongside the benefits of operational efficiencies and capital generation.

UBS predicts that Shingrix and Trelegy will account for half of forecast 2017-22 top-line growth, and combined with the margin improvements in consumer health, will generate the majority of its EBIT growth forecast.

They added: “The good news is that due to the absence of patent expiries the growth trajectory is more sustainable than it has been in a long time.”

Despite the impending arrival of generic versions of GSK’s blockbuster drugs in the US, UBS forecasts a 1% 2017-22 growth rate in respiratory, driven by Trelegy giving GSK a much broader access to the smoker’s cough market.

Meanwhile, the broker thinks that the headwinds facing the company’s HIV franchise are now “appropriately reflected in consensus estimates”.

Shares have risen by more than 10% in the past fortnight after Walmsley bowed to shareholder pressure by pulling out of the auction for Pfizer (PFE)’s consumer healthcare business. Instead, she is spending some of that money on buying out Novartis (NVS)’ 36.5% stake in their consumer healthcare joint venture for £9.2 billion.

Investors had feared major M&A activity would threaten dividends currently yielding 6% and above. Earlier this year, Glaxo indicated that another 80p dividend in relation to this financial year was on the way, maintaining a level of payment dating back to 2015.

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