GlaxoSmithKline Plc’s 2 Greatest Weaknesses

GlaxoSmithKlineWhen I think of pharmaceutical company GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.

1) Escalating competition

Drug development can be a lucrative business if, at the end of it, the newly developed treatments can be mass-marketed to score a hit with prescribers and consumers. Ongoing revenues from popular drugs can swell the coffers of pharmaceutical companies like GlaxoSmithKline for decades after the treatment’s initial introduction to markets. However, there’s often a long, expensive development phase for new drugs and even after that some formulations fail to work as hoped, and the whole development project is binned.

All that adds up to huge research and development costs for the pharmaceutical industry so there is little wonder that a system of patenting has evolved to guarantee drug developers some protection against other firms hopping onto their research results and selling copycat drugs in direct competition. It’s a system that works well, and blockbuster drugs within exclusivity periods have propelled firms like GlaxoSmithKline into the big league of British companies.

However, there’s nothing to stop drugs born of parallel research by other firms competing within the same marketing space, what we might describe as different approaches to cracking the same nut. That is exactly what has been happening to Glaxo as competition for drugs revenue hots up on the worldwide treatment-stage. On top of that, there’s a vulture-like skirmish for market share from generic drugs whenever one of Glaxo’s bestsellers times-out on exclusivity, which tends to spring the trapdoor on once-lucrative income streams.

In today’s high-tech enterprise-driven environment, such trends seem set to continue, which makes a return to high-growth seem unlikely at GlaxoSmithKline.

2) Declining cash flow

There’s no doubt that Glaxo has been struggling to maintain revenues in recent years, but what worries me the most is the firm’s recent record on cash flow. After all, it’s cash that pays the dividend, so beloved of big-pharma investors:

Year to December 2009 2010 2011 2012 2013
Revenue (£m) 28,368 28,392 27,387 26,431 26,505
Net cash from operations (£m) 7,841 6,797 6,250 4,375 7,222

We can see that flat-looking revenue has translated into a steadily falling stream of cash, with something of a rebound during 2013. However, cash flow still falls short of the 2009 level.

Glaxo has been working hard on R&D and has some promising new drugs coming through. City analysts are forecasting a return to earnings’ growth during 2015. Let’s hope that such growth can raise the on-going cash flow, which is sorely needed because, during the whole period of revenue- and cash-flow stagnation, the firm has continued to raise its dividend every year and cover from earnings is getting thin.

What now?

Despite these concerns, GlaxoSmithKline’s turnaround prospects combine with its cash-generating potential to create an interesting investment proposition.

That's why the firm features in a Motley Fool wealth report that identifies five firms with strong, defensive financial characteristics.

To find out the identity of the other four attractive stock market stalwarts, download the report free by clicking here.

> Kevin does not own any GlaxoSmithKline shares. The Motley Fool has recommended shares in GlaxoSmithKline.