Could GlaxoSmithKline plc Become A Perilous Value Trap?

Shares in pharma giant GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) have suffered a rather miserable end to what has proved for the most part a hugely tumultuous year. Prices are currently down 11% in the month to date and are within touching distance of punching a fresh three-year trough below 1,325p per share.

A plucky candidate on paper

For value investors, however, this recent weakness has provided fresh opportunity to plough into the medicines play.

Although the impact of sales-smashing exclusivity losses is expected to shove earnings 18% lower during 2014, GlaxoSmithKline still deals on a decent P/E rating of 14.7 times — any reading below 15 times is generally considered attractive bang for your buck. And expectations of a fractional earnings uptick in 2015 pushes this to just 14.5 times.

And for dividend hunters GlaxoSmithKline is an even more appetising proposition, with the firm expected to deliver dividend increases to the tune of 3% and 1% in 2014 and 2015 correspondingly. As a result the business sports a chunky yield of 5.9% through to the close of next year, blasting a forward average of 3.3% for the complete FTSE 100 clean out of the water.

Revenues growth to remain elusive?

However, I believe there are a number of issues still facing GlaxoSmithKline which could derail these earnings and dividends forecasts.

Firstly the business still needs to get to grips with the enduring problem of patent losses covering a number of key products, and eroding protection for its Advair anti-asthma treatment in particular is likely to hamper sales growth the coming years — revenues for this label slumped 25% during July-September alone.

GlaxoSmithKline has beefed up its R&D pipeline to deal with these losses, and currently has around 20 potential earnings drivers in late-stage development. Still, the persistent threat of setbacks from lab bench to pharmacy shelf — not to mention the work of its industry rivals in similar healthcare areas — does not guarantee to replace the lost revenues resulting from patent expirations.

Indeed, GlaxoSmithKline’s failure to hive off its portfolio of ‘older’ drugs which have lost exclusivity protection illustrates the possible lack of value that these products are likely to have going forward, a development which has no doubt taken the business by surprise.

On top of this, government and private health plans are increasingly playing hardball with ‘big pharma’ in a bid to drive down what they fork out for drugs, another potential turnover-smacker for the likes of GlaxoSmithKline.

I believe that GlaxoSmithKline’s vast cash flows should facilitate robust drugs development in the coming years, achieved through a combination of in-house R&D and further frantic acquisition activity, and consequently deliver a return to earnings growth. But there are many bumps in the road which could seriously undermine this recovery and disappoint value hunters, both in the near- and long-term.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.