INVESTMENT THESIS
(NYSE: GSK) is BUY. Recent results had been showing improvement, but management has taken a step back with its recent (expensive) plan to separate out its consumer products business. The company has also focused on developing multiple adjuvanted COVID-19 vaccines, as well as therapeutic options, in response to the pandemic, recently announcing Phase II/III trials for a plant-derived vaccine following positive Phase 1 results. It has also developed a protein-derived vaccine candidate in collaboration with Sanofi; however, in recent trials, the vaccine generated an insufficient immune response in older adults, and its expected launch has been delayed until 4Q21.
We see value in GSK shares, which are trading at below-industry-average P/E and price/sales multiples. The shares also offer an attractive dividend yield of 5.3%. Our target price of $45, lowered from $50, implies a P/E ratio of 15-times and a total return, including the dividend, of about 24% from current levels.
RECENT DEVELOPMENTS
The beta on GSK is 0.75.
Glaxo is based in the UK and reports results in pounds (GBP). For the third quarter of 2020, total revenue declined a pro forma 5% at the coupon equivalent rate (CER) to GBP 8.6 billion. Adjusted operating profit rose 4% CER to GBP 2.67 billion, while adjusted earnings per share rose 1% to 35.6 pence. In U.S. dollars, at the average 3Q exchange rate of 1 GBP/$1.30, earnings came to $0.92 per ADR, above the consensus estimate of $0.85. For the first three uarters, the company generated sales of GBP 25.4 billion, down 2% on a pro forma CER basis, and adjusted earnings of $2.41 per ADR.
The company’s primary aim is to develop multiple adjuvanted COVID-19 vaccines. Phase II/III studies have been initiated by Medicago and GSK for the plant-derived vaccine candidate for COVID-19, following the release of positive Phase 1 results. GSK is also working with Clover Pharmaceuticals to study a separate adjuvanted COVID-19 vaccine candidate, and has developed a protein-derived vaccine candidate with Sanofi; however, in recent trials, this vaccine generated an insufficient immune response in older adults. The companies are now working to refine the concentration of antigen in order to provide stronger immune responses across all age groups, with the goal of launching the product in 4Q21.
The company is also exploring therapeutic options. A pivotal study of partner Vir’s antibody for high-risk outpatients is ongoing, with initial data expected by the end of 2020. Management believes the antibody candidate could become a best-in-class asset due to its unique receptor binding site, its ability to recruit immune cells to kill off infected cells, and its extended half-life. A Phase III study is ongoing.
However, management said that it was encouraged by the recovery towards pre-COVID levels of immunization as the quarter progressed, articularly for flu vaccinations.
It expects earnings to decline 1%-4% in 2020, most likely at the lower end of the range, and the dividend to remain flat with 2019.
EARNINGS & GROWTH ANALYSIS
We’ll start our analysis of 3Q business trends at the top line. Pharmaceutical sales accounted for 48% of revenue and fell 3% year-over-year in constant currency. Glaxo’s largest category in Pharmaceuticals is Established, featuring the former blockbuster drug Advair/Seretide. The drug now faces generic competition, and has been under severe pricing pressure. Established drug sales, which accounted for 41% of total Pharmaceutical sales, declined 18% year-over-year.
Glaxo’s fastest-growing Pharmaceutical category in 3Q was Oncology, which accounted for 2% of Pharmaceutical sales and grew 58% in CER to GBP 99 million. Oncology sales were driven primarily by Zejula, which the company acquired in 1Q19, as well as by the launch of Blenrep in the U.S. and Europe. Respiratory product sales, which accounted for 23% of the Pharmaceutical category, grew 26%, reflecting strong sales of Trelegy, Revlar/Breo, and Nucala in all regions. In Immuno-inflammation, which accounted for roughly 5% of 3Q Pharmaceutical sales, sales rose 18%, driven by Benlysta and the launch of Duvroq in Japan.
Management noted that vaccines were affected by continued lower demand in some countries due to pandemic-related restrictions. However, management said wellness visits have mostly returned to prior-year levels for children and adolescents.
Management noted that the pandemic continued to hurt segment results.
In addition to boosting the top line, Glaxo is working to drive EPS growth through margin improvement. The adjusted operating margin in 3Q20 was 30.8%, up 220 basis points from the prior year. The increase reflected restructuring efforts and strong cost controls.
Other promising Glaxo products include the recently launched Blenrep, for multiple myeloma, and Trelegy, for asthma, as well as Nucala, which was recently approved for additional indications.
Our five-year EPS growth rate estimate for GSK is 7%.
FINANCIAL STRENGTH & DIVIDEND
Total debt was GBP 36.5 billion, for a debt/capital ratio of 58%, down from 62% at the end of 2019.
GSK also has access to significant additional undrawn sources of financing if required.
MANAGEMENT & RISKS
Emma Walmsley has served as the CEO since 2017. Prior to becoming CEO, Ms. Walmsley had been the CEO of GSK Consumer Healthcare since its creation in 2015. Iain Mackay has served as the CFO since 2019. Prior to joining GSK, Mr. Mackay was Group Finance Director at HSBC.
In recent years, Glaxo has transformed its businesses and strategy through a series of deals, focusing on its strengths while exiting noncore businesses. It has now repurchased this business from Novartis and combined it with assets acquired from Pfizer.
Investors in GlaxoSmithKline face several risks, some inherent to the pharmaceutical industry and others specific to GSK. Among the former is the risk of drug development — some candidates will fail to progress for technical or commercial reasons, particularly in late-stage development, which may materially affect the company’s outlook and the valuation of the shares. In addition, drug approval and reimbursement depend on regulatory agencies throughout the world.
COMPANY DESCRIPTION
The company’s leading products include treatments for asthma and COPD; products for HIV infection; and a range of vaccines.
VALUATION
From a fundamental standpoint, now that Glaxo’s earnings have become more consistent, we are valuing the shares based on P/E, in addition to price/sales and yield. Our target price of $45, lowered from $50, implies a projected 2021 P/E of 15 and a total return, including the dividend, of about 24% from current levels.
On December 11, BUY-rated GSK closed at $37.59, down $0.38.
Source: Argus
