Why I’m Selling GlaxoSmithKline plc And Buying Shire PLC

Finding a company that has the perfect blend of both growth and income is a difficult game to play. However, it looks as if Shire (LSE: SHP) could be the perfect pick.

Up until now, my pharmaceutical sector favourite has been GlaxoSmithKline (LSE: GSK), due to the company’s impressive dividend yield and market leading position in the consumer healthcare market.

Unfortunately, Glaxo is struggling to grow and that’s why I’m looking to reduce my holding and build a position in Shire.

No growth

Glaxo is a great company. It has all the traits you need in a long-term pick: a defensive product offering, well-covered dividend and leading position in many markets.

Nevertheless, revenues for legacy drugs are declining as the group loses exclusive manufacturing rights. While the company does have a pipeline of 40 new treatments under development, it’s going to take years for these new products to have an effect on the bottom line. 

Indeed, City analysts expect Glaxo’s earnings to fall marginally this year before returning to steady, mid-single-digit growth during 2016. This kind of growth is nothing to get excited about. 

On the other hand, Shire has an ambitious six-year plan for growth. Specifically, when AbbVie’s deal to acquire Shire fell through last year, management stated that the group was aiming to double annual sales to $10bn by 2020. And using this figure, it’s possible to work out the price Shire’s shares will be changing hands for by then. 

For example, over the past five years Shire’s net profit margin has averaged 20%, although City analysts expect the group’s net margin to hit 35% over the next three years. If Shire’s revenue has increased to $10bn by 2020, a net margin of around 35% means that the group will report a net profit of $3.5bn, around £2.3bn for the full-year 2020.

On a per share basis, this net profit figure translates into earnings per share of £3.90, based on the current number of shares in issue.

Then there’s Shire’s valuation to consider. Indeed, over the past decade the company has traded at an average P/E of 20. So, using this multiple and factoring in Shire’s projected EPS figure for 2020, it’s reasonable to assume that the group’s shares will be worth £78 each within five years. That’s a gain of 64% from present levels.

Income play 

However, unlike Glaxo, which offers an impressive dividend yield of 5.4%, at present levels, Shire’s current dividend yield of 0.3% is nothing to get excited about. But once again, if you look to the future, Shire’s dividend has huge growth potential. 

Currently, Shire’s dividend payout is covered around 13 times by earnings per share, and the group is retaining the majority of its earnings.

In comparison, the rest of Shire’s peers return the majority of their income to shareholders. Shire’s peers have an average dividend cover of 1.2 times, indicating that, on average, Shire’s peers are returning 80% of earnings to shareholders via dividends. 

Over the long-term, it’s likely Shire will initiate a similar dividend policy. So, working back once again, if Shire pays out 80% of 2020’s projected earnings of £3.90 per share, the company is set to offer a dividend of around £3.12 per share during 2020, a yield of 6.6% based on current prices. 

All in all, then not only does Shire offer the potential for rapid growth but there’s also scope for the company to become an income investment over the long-term. 

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Rupert Hargreaves owns shares of GlaxoSmithKline. 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.