3-Point Checklist: Should You Buy GlaxoSmithKline plc Or AstraZeneca plc?

In a battle between the UK’s two pharma giants, which firm has the edge, GlaxoSmithKline plc (LON:GSK) or AstraZeneca plc (LON:AZN)?

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GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) recently completed a complex multi-billion dollar asset swap deal with Swiss firm Novartis, which I believe will help to kick-start Glaxo’s earnings growth and maintain the firm’s enviable cash generation and profit margins.

However, UK peer AstraZeneca (LSE: AZN) (NYSE: AZN.US) isn’t without its fans — in fact, the market is so confident in AstraZeneca’s prospects that the share price has retained most of the bid premium it accumulated last year, leaving the shares 16% higher than they were one year ago.

That’s a much better performance than GlaxoSmithKline (down 3%) or the FTSE 100 (up 4%) — so which company should you invest in today?

1. Profitability

Both companies are going through a period of change at the moment, and this is reflected in profit margins, which tumbled last year due to a mixed bag of exceptional costs.

In the table below, I’ve highlighted each company’s reported operating margins and their five-year average operating margins:

 

GlaxoSmithKline

AstraZeneca

Five-year average operating margin

22.9%

24.9%

2014 reported operating margin

15.6%

8.2%

Historically, both companies enjoyed very high operating margins — and those good times may well return.

Certainly both companies hope so: the adjusted ‘core’ profit figures published by each firm for 2014 give GlaxoSmithKline a core operating margin of 28.7% and AstraZeneca a similar figure of 26.6%.

However, many of the one-off costs reported last year have happened before — and may happen again. I reckon rebuilding both firms’ profit margins could take a few more years.

2. Income

The main attraction of both firms is income: historically, AstraZeneca and GlaxoSmithKline have offered high yields and strong dividend growth.

Today’s the yields remain attractive, but growth has slowed — so which firm looks more attractive?

 

GlaxoSmithKline

AstraZeneca

2015 prospective yield

5.1%

4.1%

Five-year dividend growth rate

+4.2%

1.9%

GlaxoSmithKline shareholders will also receive an 82p per share payout this year, as part of the recently-completed Novartis deal. This will add another 5.1% to Glaxo’s yield for 2015.

There are question marks over whether either firm will be able to increase its payout in 2015, but the benefit of the doubt has to go to GlaxoSmithKline, in my opinion.

3. Is the price right?

Neither AstraZeneca nor GlaxoSmithKline is obviously cheap, but I think that generous yields, decent profit margins and strong cash generation — plus expectations of future growth — mean that both look reasonably attractive at current prices.

 

GlaxoSmithKline

AstraZeneca

2015 forecast P/E

17.2

16.2

2016 forecast P/E

16.5

16.5

There’s not much in it: my view remains that Glaxo’s deal with Novartis will help the firm escape the impact of recent patent expiries and give Glaxo a head start over AstraZeneca in returning to growth.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares in GlaxoSmithKline. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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