The Motley Fool

How GlaxoSmithKline plc & SkyePharma PLC Can Turbocharge Your Returns

On the face of it, GlaxoSmithKline (LSE: GSK) looks like the perfect investment. The company is one of the world’s largest pharmaceutical groups, which owns a vast consumer products business, highly profitable vaccines business and pharmaceuticals division.

However, Glaxo is faced with losing US market exclusivity on its best-selling asthma drug Advair this year, along with the additional patent on the Diskus inhaler used to deliver the drug, which has so far kept competitors at bay. Two years ago sales of this drug were responsible for almost a fifth of Glaxo’s sales but last year Advair sales as a percentage of overall group sales declined 13%.

The loss of patent protection on Advair could be described as Glaxo’s Achilles heel but the average investor can negotiate around this structural shift in the company’s business model by diversifying.

And one of the best companies to buy alongside Glaxo in a portfolio is SkyePharma (LSE: SKP).

A profitable merger

Skye has recently agreed to merge with peer Vectura, to create a new UK champion in respiratory medicines. Vectura is also developing its own generic version of Advair in partnership with Roxane Labs, a US manufacturer being acquired by UK-listed Hikma. Skye and Vectura both specialise in the formulation and delivery of inhalable respiratory drugs, working in partnership with bigger groups including Glaxo and Novartis.

All in all, this deal will generate some impressive returns for investors. Vectura predicts the deal would be earnings-enhancing in its first year, with projected annual pre-tax synergies of £10m by 2018. It’s Vectura that’s leading the deal here. Under the terms of the deal, Skye’s shareholders are set to receive 2.7977 new Vectura shares for each Skye share, valuing the latter at 449.89p each – a small premium to today’s price.

Current outlook 

Current City figures are calling for Vectura to report earnings per share of 5.1p for the year ending 31 March 2016, which means that the group’s shares are trading at a forward PE of 28.9. However, analysts have pencilled in total earnings per share growth of more than 100% for the next two years to 10.8p per share, and these forecasts could be revised significantly higher if the deal with Skye goes to plan and integration is successful. Shares in Skye trade at a forward P/E of 22.2.

Skye and Vectura are an excellent hedge against Glaxo’s patented expiry but both companies are relatively expensive and neither offer a dividend for investors. Meanwhile, Glaxo’s shares support a dividend yield of 5.9% and trade at a forward P/E of 16.2. Management has made a commitment to maintain the payout at 80p per share for the next few years.

The bottom line 

So overall, Glaxo is an excellent income investment for any portfolio, and the company is set to return to growth over the next two years. Still, some investors are concerned about Glaxo’s patent cliff and the best way to hedge against this risk is to diversify into Skye, a company that is currently in the process of being bought out for a small premium and specialises in the market where Glaxo is set to lose market share.

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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.