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Why GlaxoSmithKline plc And Hutchison China MediTech Limited Are A Perfect Pairing

Top FTSE 100 pharmaceuticals group GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) is a £67bn giant. AIM-listed Hutchison China MediTech (LSE: HCM) is 75 times smaller. But there’s more than just diversification by size that could make these two companies a perfect pharma pairing in your portfolio.

Heavyweight Glaxo is a core holding for many investors. The company has experienced a few difficult years, due to a number of factors — including expiring exclusivity on a number of its best-selling products and pressures on public healthcare budgets in some of its major markets — but the fundamental attractions of the business remain intact.

Size, maturity and other defensive qualities, along with substantial cash dividends, continue to make Glaxo an appealing choice to help form a solid foundation for a portfolio.

Furthermore, Glaxo currently appears reasonably priced at under £14. Recent earnings declines are expected to bottom out this year. The forecast P/E for next year is a reasonable 15.7, and management has guided on compound annual earnings growth in mid-to-high single digits for the period 2016-20. While the company intends to hold the annual dividend at 80p through to 2017, as earnings growth rebuilds, the yield is an attractively high 5.8%.

So, Glaxo appears set to deliver a reasonable total return over the next five years (assuming a constant P/E), with perhaps as much as half the return coming from the dividend.

Meanwhile, Hutchison China MediTech (Chi-Med) has a very different return profile, predicated entirely on growth, which could be spectacular. Chi-Med pays no dividend and appears unlikely to do so any time soon.

Many investors may be put off immediately by a sky-high P/E of 115, but you really need to look beyond it. Chi-Med’s fast-growing wellbeing, over-the-counter and prescription dugs businesses are profitable and cash generative, but the cash is being recycled into a development pipeline of innovative oncology and immunology drugs. The company ended 2014 with 7 drug candidates, with 16 clinical studies running (10 of which are in potential Breakthrough Therapy indications).

There’s been plenty of positive news since the year end on clinical trials, but also on other aspects of Chi-Med’s business: for example, an exclusive distribution agreement for Seroquel (AstraZeneca‘s antipsychotic treatment) in China, and — just today — patent protection in China through to 2029 for Chi-Med’s best selling prescription drug She Xiang Bao Xin (for the treatment of cardiovascular diseases).

Founded in 2000, Chi-Med has built the infrastructure, products and commercial relationships to realise its vision. The company says: “The route to our objective of becoming a large-scale China pharmaceutical company is now clearly laid out before us”.

As well as providing an exciting growth prospects to complement Glaxo’s mature business and relatively staid returns, Chi-Med is also a perfect partner in terms of its geographical focus. Chi-Med is thoroughly embedded in China, while Glaxo’s position in the world’s largest economy (and growth opportunity) has become problematic.

Glaxo was making good progress in China up until 2013, when the company was rocked by a bribery scandal. The result was a £300m fine and suspended jail sentences for some personnel. Glaxo’s pharmaceuticals and vaccines sales in China dived 29% in 2013, with sales of consumer products also declining. 2014 saw a further 1% decline in the former and a 5% decline in the latter. Glaxo has its work cut out to rebuild its business and reputation in China.

I mentioned earlier that Glaxo’s shares appear good value at the moment. Chi-Med’s do, too. Having climbed to just shy of £20 on the back of this year’s newsflow, they’ve lately pulled back to nearer £17. As such, I think now could be a good time to pick up this perfect pharma pairing.

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G A Chester 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.