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Why I believe you can double your money with Footsie champion GlaxoSmithKline plc

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Scientist filling a needle
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GlaxoSmithKline (LSE: GSK) is one of the FTSE 100’s income champions. Despite stagnating earnings, over the past four years the company has paid out 80p per share annually to investors without fail for an average dividend yield over the period of 5.6%, around 1.8% higher than the FTSE 100 average over the period. 

However, recently shares in the pharmaceutical giant have come under pressure. Analysts have started to speculate that the group’s dividend record is under threat as new CEO Emma Walmsley eyes up possible acquisitions. 

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Buying growth 

Since 2012, Glaxo’s earnings have been treading water. The company reported earnings per share of 111p for 2012 then they fell to a low of 76p before rebounding to 102p last year. Analysts have pencilled in earnings per share of 110p for full-year 2017. 

Although other factors have contributed, the loss of exclusive manufacturing rights for the company’s blockbuster Advair drug has been responsible for the bulk of the earnings slide and Glaxo has also been underinvesting for years. The group’s research spend as a percentage of sales is less than 14% compared to its peer average of around 18%. AstraZeneca, Merck, and Bristol-Myers Squibb spent more than 25% of their revenues on R&D in 2016.

Walmsley wants to reverse this trend. She believes that Glaxo should move back to its scientific roots and search for the blockbuster drugs of the future. To this end, the new CEO has dropped 30 development programmes to focus on what she believes will be the real winners. 

She is also eyeing up acquisitions. Management has said it will take a look a Pfizer‘s consumer healthcare business as well as potentially acquiring the rest of the consumer joint venture it has with Novartis. Moreover, for the first time in over nine decades, the group has set up a team to look at smaller acquisitions in the domestic UK market. 

Cash flow crunch 

If Glaxo wants to ramp up spending, I believe management will have to cut the group’s dividend to free up cash. This might be unpalatable for income investors, but I think it will result in better long-term capital gains. 

As growth returns, the market should re-rate the stock to a more attractive multiple, producing potentially better returns than the current 5.9% dividend yield. For example, right now shares in Glaxo are trading at a forward P/E of 12.7 compared to the pharmaceuticals industry sector average of 18.8. If the market re-rates the stock on growth expectations up to the sector average, the shares could be worth 2,068p, a gain of 53% from current levels. 

Deals could help push the stock higher still. Pfizer’s consumer goods division generates around $3.4bn per annum in sales and a profit margin of around 20% suggests that this could boost Glaxo’s bottom line by around $700m, or approximately 10%. Buying the rest of the business with Novartis could add an extra 10% after extracting synergies. 

According to my figures, these deals could boost earnings per share to around 140p. At a sector average valuation, this implies a share price of more than 2,630p, nearly 100% above current levels. 

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Rupert Hargreaves owns shares in GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended AstraZeneca. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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