There has been no respite for Glaxo (LSE: GSK) shares in recent weeks as investors have remained unenthused by the company’s performance, with the stock falling by 6% during the month and bringing shareholders a year-to-date loss of 5.1% on their holdings.
Much of this recent performance has been due to the fact that the much vaunted R&D day at the beginning of this month left investors somewhat underwhelmed.
Management spoke a lot about how they could file for regulatory approval on up to 20 new drugs before 2020. However, 20% of the total appear to be generics, while the board only sees seven of twenty as having a chance of actually coming onto market before 2020.
This obviously prompts a number of questions, so for those who are wondering whether it is worth holding onto the shares, here are some more thoughts.
Far from secure
The disappointment in R&D now places a significant question mark over Glaxo’s ability to maintain its dividend commitments through till 2020.
Based on current forecasts, at least some of the dividend will need to be paid from reserves in the current year, as the consensus for 2015 suggests earnings per share will be in the region of 77.0p. In plain English, this means dividend cover of sub 1x.
The outlook for 2016 doesn’t appear much better either, with current estimates suggesting earnings per share of 85.1p, which is also below the likely level of total dividends for the period.
Furthermore, if we assume that Glaxo’s future income stability is far from secured by its current pipeline, we are forced to accept that M&A may become a necessity for management.
This will probably mean the issuance of debt as well as the drawing down of reserves, which only serves to make the dividend outlook all the more questionable.
The wild card
The wild card in all of this appears to be GSK’s HIV business, which has performed better than many expected in recent periods.
If forecasters are to be believed then the ViiV Healthcare franchise could bring in up to £2.5bn annually for Glaxo by the close of 2017, which is a significant shot in the arm in terms of revenue.
However, this still leaves the group staring down the barrel of a significant revenue gap if it’s Advair business falls all of the way into obscurity during the same time period and, as such, it is not possible to say whether a successful performance in HIV will be enough for Glaxo.
Preserve of the patient
Despite the above, it is not all doom and gloom.
The investment case for the group remains strong over the long term, with the option of outward M&A still a viable strategy over the near-medium term, while ongoing scope for a more robust approach to costs could still help to smooth over some of the creases in the coming years.
Furthermore, recent chatter from across the pond has highlighted the potential for inbound M&A to also be a source of shareholder returns, with Pfizer executives ‘fessing up’ to having contacted GSK about the prospect of a tie up.
At present GSK trades at 16.9x the consensus estimate for earnings per share in 2015, which represents a modest premium to comparable peers such as Astrazeneca and Shire but a discount to the 17.4x sector average.
My guess is that the group will either continue to pursue organic growth over the medium term or management will finally put their heads together and come up with a credible M&A strategy.
Regardless of which option they eventually go for, it’s looking increasingly like it is only a matter of time before investors begin to question the viability of GSK’s commitment to a progressive dividend.
This could prove a further headwind for the shares over the near to medium term, which means that new or continued investment into Glaxo will probably remain the preserve of the patient for at least the foreseeable future.
