A rise of over 7% in Hikma‘s (LSE: HIK) share price took place following its results release on Wednesday. Investors seem to be impressed with the progress made in the integration of the West-Ward Columbus acquisition, as well as the company’s long-term growth rate. This upbeat outlook could lead to further gains for its share price – especially as it trades on a relatively enticing valuation.
Hikma’s 2016 results showed a marked improvement on the prior year. Revenue increased by 39% in constant currency, while core operating profit was 14% higher. These improved numbers came at a time of great change for the business, which perhaps shows just how impressive they are. The business acquired West-Ward Columbus in 2016, which is its largest acquisition to date. Alongside the acquisition of EUP, this improves Hikma’s long-term growth prospects and could lead to a rising bottom line through synergies and a stronger position in fast-growing markets such as Egypt.
Hikma intends to increase investment in R&D, which should boost its growth potential. It remains upbeat about the prospects for its Generics business in particular since there is potential for portfolio optimisation. It will also develop higher value products in future in order to improve efficiencies and drive through productivity improvements so as to create a leaner and more profitable business.
Despite Hikma’s 7% gain following Wednesday’s results, its shares appear grossly undervalued. The changes it is making to its business and the improved business model it is moving towards do not appear to be factored-into its valuation. For example, in 2017 the company is expected to record a rise in its earnings of 37%, followed by further growth of 29% next year. However, its price-to-earnings growth (PEG) ratio of 0.5 indicates there could be major upside potential on offer over the long run.
In terms of its growth potential, Hikma is more attractive than sector peer GlaxoSmithKline (LSE: GSK). It is expected to report a rise in earnings of 9% this year, which puts it on a PEG ratio of 1.7. While attractive, it is far less so than Hikma’s valuation. As such, the potential rewards from investing in Hikma could be higher than for GlaxoSmithKline.
However, GlaxoSmithKline offers superior income prospects when compared to its sector peer. While Hikma currently yields just 1%, Glaxo has a yield of 4.8%. Certainly, dividend growth at Hikma could be brisk, but with major investment in R&D and in acquisitions, Glaxo is likely to offer stronger income returns in the long run. With inflation on the rise, it could therefore benefit from improving investor sentiment in future years.
Furthermore, Glaxo may be less risky than Hikma due to its more stable business model. It has not made major acquisitions recently, while Hikma has sought to boost its profitability through M&A activity. As with any company, integration carries risk and while cost synergies are currently on track for the West-Ward Columbus deal, there is no guarantee they will continue to be delivered as expected. Therefore, while both companies appear to be worth buying and holding for the next decade, Glaxo may have the more enticing risk/reward ratio.
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Peter Stephens owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Hikma Pharmaceuticals. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.