For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.
That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.
To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:
- Prospects;
- Risks;
- Valuation.
Today, I’m looking at pharmaceutical giant GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US).
Track record
With the shares at 1679p, GlaxoSmithKline’s market cap. is £78,679 million.
This table summarises the firm’s recent financial record:
| Year to December | 2008 | 2009 | 2010 | 2011 | 2012 |
|---|---|---|---|---|---|
| Revenue (£m) | 24,352 | 28,368 | 28,392 | 27,387 | 26,431 |
| Net cash from operations (£m) | 7,205 | 7,841 | 6,797 | 6,250 | 4,375 |
| Adjusted earnings per share | 104.7p | 121.2p | 53.9p | 114.1p | 112.7p |
| Dividend per share | 57p | 61p | 65p | 70p | 74p |
1) Prospects
Glaxo presents ‘core results’ that omit the effects of items such as intangible asset amortisation and impairment, major restructuring costs, legal costs, and acquisition accounting. However, I’m going to look at total results, as Glaxo is a huge organisation that has been struggling to grow recently and it is engaged in an ongoing process of reshaping its operations. That involves disposals, acquisitions and restructuring, which could become a longer-term feature of Glaxo’s operations.
Last month’s third-quarter results statement showed flat turnover and operating profit down 15% compared to the year-ago figures. A 9% fall in sales from emerging markets and the Asia Pacific region has contributed to the results, although most other regions achieved modest single-digit growth.
The firm’s Emerging Markets and Asia Pacific category contributed 25% of sales, so it’s important. Within that sector, well-reported problems in China where the firm is under investigation for misconduct have caused a 61% sales decline. Meanwhile, 33% of sales came from the US, 29% from Europe, 7% from Japan and the remaining 6% from other regions.
However, the CEO reckons that 2013 is shaping up to be a key year for R&D, resulting in new product launches, each one full of sales-boosting potential. As the firm focuses on launching its new pipeline, it is also selling off non-core assets and parts of the business capable of realising shareholder value. Announcements of the sale of the Lucozade and Ribena brands to Suntory and the sale of Arixtra and Fraxiparine, for a combined £2.05 billion return, demonstrate the point.
Future growth drivers include the potential for the firm’s new products to take off and for problems in China to be resolved.
2) Risks
According to the CEO, Glaxo has been facing increasing price competition in its biggest market the US. Even drugs under patent protection face competition from alternatives from other producers. There’s also a lot of generic competition, in all markets, for older products that have timed-out on exclusivity.
When cheap imitations swamp a market, revenues, margins, and profits are only going one way: down. It’s that kind of threat that seems responsible for Glaxo’s declining overall financial performance, which shows in the table above. As more drugs lose exclusivity going forward, the firm faces a big R&D push to regenerate its product pipeline, which looks to be analogous with running up the down elevator – progress will be hard won.
Poor financial performance seems to have galvanised Glaxo into refocusing its business on core activities and cost cutting by bearing down on inefficiencies. The risk, then, is that complacency could once again set in if the firm returns to growth, thus allowing inefficiencies and lack of focus to return.
3) Valuation
Most Glaxo investors seem to buy in for the dividend stream. The forward yield is running at about 5.1% for 2014, with City analysts expecting forward adjusted earnings to cover the payout around 1.5 times – actual earnings will probably provide a lower dividend-cover figure.
A forward P/E rating of around 13 seems well up with the 7% earnings uplift expected in 2014, even when considering the dividend payment.
Conclusion
Glaxo’s business does not appear to be an easy game. My investing guide here is dividend yield, and on that score, despite the large payout, I’m uncomfortable with the low level of dividend cover from earnings.
