Shares in GlaxoSmithKline (LSE: GSK) were given a boost this week when it reported better-than-expected quarterly results. Furthermore, it announced that its transformation programme is on track and that the company in on target to deliver £3bn in annual cost savings by 2017.
This is a welcome relief for GlaxoSmithKline’s investors, with its blockbuster drug Advair’s sales coming under pressure and it having delivered disappointing financial performance in recent years. However, its share price performance still indicates that many investors are lukewarm about the future outlook, with GlaxoSmithKline’s valuation having fallen by 6% in the last year.
Looking ahead, the company has huge growth potential. As well as cost reductions, the most recent quarter saw a rise in sales of 6% in the full-year. And with the company’s collaborations and pipeline having huge potential, there’s the prospect of strong earnings growth over the medium term. In fact, as soon as this year, GlaxoSmithKline is expected to grow its bottom line by as much as 11%, which puts it on a forward price-to-earnings (P/E) ratio of 16.7.
This compares favourably to healthcare sector peer Smith & Nephew’s (LSE: SN) rating of 18.6. With it due to deliver a rise in earnings of just 1% this year, the prospects for share price growth seem to be less favourable than those of GlaxoSmithKline.
Of course, Smith & Nephew offers greater stability than GlaxoSmithKline owing to its focus on wound care and orthopaedics. They’re less cyclical businesses than pharmaceuticals and aren’t subject to the boom and bust patent cycle, with evidence of this being seen in Smith & Nephew’s track record of earnings growth. In the last five years it has recorded an increase in earnings in every year.
However, with GlaxoSmithKline yielding 5.7% and Smith & Nephew yielding 2%, the former could prove to be the better defensive income play in the long run.
Long-term growth, short-term risk
Meanwhile, Shire (LSE: SHP) continues to have a bright long-term future. However, its $32bn combination with Baxalta brings a high degree of uncertainty and means that buying Shire is perhaps riskier now than it previously was. Although GlaxoSmithKline is undergoing a major transition that could ultimately prove to be unsuccessful, it appears to be making excellent progress and is well on its way to achieving its goals. Shire, though, is now at the start of an integration process that could throw up multiple challenges.
For example, the combination between Shire and Baxalta may not be such a perfect fit. The two companies have little overlap regarding the types of diseases in which they specialise, and that means synergies could be somewhat limited. Therefore, with GlaxoSmithKline having an excellent pipeline of new drugs as well as an appealing valuation and a high yield, it appears to be the preferable buy right now.
