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Is It Time To Give Up On GlaxoSmithKline plc?

At the time of its creation during 2000, GlaxoSmithKline (LSE: GSK) was the world’s largest pharmaceutical company with a bright future. However, 15 years later and the group has slipped down the rankings and is now the world’s seventh largest pharma company.

What’s more, Glaxo’s shares have underperformed those of its of its larger peers, and international stock indexes by around 50% over the past 15 years, excluding dividends. The world’s largest pharma ETF, PowerShares Dynamic Pharmaceuticals, has outperformed Glaxo by a shocking 400% since 2005. 

But are these dire returns a reason to dump Glaxo? Or does the company have a trick up its sleeve that could re-ignite growth?

Restructuring 

Glaxo’s boss, Sir Andrew Witty, who came to power during 2008, has changed Glaxo’s direction over the past six years. Indeed, the company is now focused on the non-drug, vaccines and consumer healthcare side of the industry.

At the same time, Sir Witty has pushed the company to withdraw from the more complex areas of drug discovery, including the red-hot market of immuno-oncology anti-cancer therapies. 

Management has decided to take this route for one simple reason; Glaxo finds the economics of healthcare challenging. 

Challenging economics 

Developing new drugs for sales isn’t cheap. And even after spending billions developing treatments, only around 7% of new drugs are approved for sale. 

So, the drugs that do manage to make it through the gauntlet of fire have to be home-runs. 

Unfortunately, this is not always the case. Moreover, as populations around the world age, healthcare budgets are coming under pressure and consumers are increasingly seeking out cheaper alternatives to expensive treatments.

As a result, the returns generated from the research, development, production and sale of treatments are falling. Glaxo’s management believes that it won’t be long before the economics of drug discovery unravel. 

It’s this belief that has pushed Glaxo to keep its distance from the drug development side of the business.

The risk of poor returns has also kept Glaxo from doing any big deals recently. While the company’s larger peers have been spending billions to buy-up smaller innovative rivals, Glaxo has waited on the side-lines. 

Faster growth 

All in all, Glaxo’s management believes that selling vaccines and consumer products into global healthcare markets, will offer faster growth, with a better a return, than the overcrowded complex drugs market. 

However, only time will tell if Glaxo has made the right decision or a costly mistake. 

That said, there’s not really much that can go wrong for Glaxo. The company’s growth may stagnate if management’s prediction turns out to be wrong. However, sales of vaccines and consumer products are unlikely to evaporate, making Glaxo a low-risk, highly defensive investment. 

Income play

With a steady stream of income from the sales of vaccines and consumer products, Glaxo’s management has been able to guarantee the company’s dividend payout at its current level of 80p per share of the next three years.

This means that even if Glaxo fails to grow over the next three years, investors are set to receive dividends totalling 240p per share in income over the period. A total yield of 16.6% based on current prices.

Glaxo’s dividend payout is currently covered 1.2 times by earnings per share. 

Growth play

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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.