Are GlaxoSmithKline plc, Bunzl plc And Associated British Foods plc Worthy Of Their Premium Valuations?

Today’s results from distribution and outsourcing group Bunzl (LSE: BNZL) show that it’s making encouraging progress, with adjusted earnings growing by 7% in 2015. This growth was aided by a 5% increase in revenue, while an operating margin rise of 10 basis points also helped to improve profitability.

Clearly, Bunzl’s acquisition-focused business model is highly successful, with it spending a record £327m in the 2015 financial year on 22 businesses, including today’s separate announcement of the purchase of Dental Sorria. And with its operating cash flow rising to £443m in 2015 alongside a cash conversion ratio of 97%, Bunzl seems to be in a strong position to engage in further M&A activity over the coming years.

Despite this, Bunzl may not be an attractive investment at the present time. That’s because its valuation appears to be rather high, with the company’s shares trading on a price-to-earnings (P/E) ratio of 20.9. This is a significantly higher rating than the FTSE 100’s P/E ratio of around 13 and with Bunzl expected to grow its bottom line by just 5% this year and 3% next year, there appear to be better options available elsewhere.

Lacking income appeal

Similarly, ABF (LSE: ABF) also appears to be overvalued. Certainly, as a business it’s highly appealing and its retail division in particular is performing exceptionally well. The value-focused Primark brand seems to be highly resilient and remains popular even though disposable incomes in the UK are rising in real terms and are therefore likely to make consumers less price-conscious. As such, further growth is very much on the cards.

However, with ABF trading on a P/E ratio of 33.1, its valuation seems to more than adequately factor-in its future growth potential. And with a yield of 1.1%, ABF also lacks income appeal since the FTSE 100 offers a yield that’s almost four times higher. In addition, ABF is expected to post a fall in earnings of 1% in the current financial year and this indicates that investor sentiment could deteriorate in the short run, thereby making other options appear more preferable.

Pricey but profitable?

One example is GlaxoSmithKline (LSE: GSK). Like ABF and Bunzl, it trades at a premium to the FTSE 100, with it having a P/E ratio of 16.5. However, GlaxoSmithKline’s valuation could move significantly higher since it has a very strong and well diversified portfolio of new drugs in its pipeline, with there being the potential for the delivery of blockbuster drugs over the medium-to-long term. For example, GlaxoSmithKline’s ViiV Healthcare division has considerable potential to boost group profitability moving forward.

As well as growth potential, GlaxoSmithKline also offers profitability that’s less highly correlated with the wider economic outlook. In this sense, it’s a better defensive option than ABF or Bunzl, since they’re more dependent on the performance of the global economy. And with GlaxoSmithKline yielding 5.7%, it continues to be an excellent income prospect too.

Certainly, there’s work to be done regarding cost savings and efficiencies, but GlaxoSmithKline has made a sound start in this respect and appears to have the right strategy through which to deliver impressive total returns in the long run.

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Peter Stephens 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.