The Motley Fool

Why I believe the GlaxoSmithKline share price is now too cheap to ignore

It seems over the past year, the GlaxoSmithKline (LSE: GSK) share price has gone nowhere but down. For the year to March 21, the FTSE 100 declined 4.5% while shares in Glaxo dropped 23%, excluding dividends.

However, over the past few weeks, the stock has recovered some ground while the rest of the market has floundered. Year-to-date, shares in Glaxo are now up by 6.4%, excluding dividends, compared to the FTSE 100’s decline of 7.2%. 

And even after this mini-rally, I believe the GlaxoSmithKline share price is too low to ignore.

The sector’s cheapest 

A quick glance at Glaxo’s valuation metrics tells you a lot about this company. The stock is currently trading at a forward P/E ratio of just 12.8 and supports a dividend yield of 5.8%. Compared to its larger US peers such as Johnson & Johnson, Merck & Co Inc, Bristol-Myers Squibb Co and Eli Lilly and Co, which together trade at an average forward P/E of 15.7, Glaxo looks undervalued by around 19%. 

On an enterprise value to earnings, before interest tax depreciation and amortisation basis (EV/EBITDA) which factors in a company’s debt in the evaluation process, Glaxo is trading at an EV/EBITDA ratio of 10.3, compared to the sector average of 15.3.

Put simply, it shows that Glaxo is drastically undervalued compared to its peers.

What’s behind the valuation gap? 

The reason why the company is trading at this level is not so easy to explain. The stock has come under pressure partly due to worries that it may cut its dividend to fund acquisitions, and partly due to investors’ concerns that Glaxo’s growth outlook is limited.

The first of these two overhangs was laid to rest (for the time being at least) when Glaxo announced that it was pulling out of the race to buy Pfizer’s consumer healthcare unit in March. A short time after this announcement, the company announced that it had agreed to buy Novartis’s 36.5% stake in their consumer healthcare joint venture for $13bn in cash. Management believes the deal will boost earnings by about 5% in 2019 and could add even more going forward. 

What’s more, by merging the business into its existing consumer arm, management believes it can push operating margins from 17.7% to the mid-20s by 2022. 

Even though this deal means Glaxo’s debt will rise to 2.5 times operating earnings, according to City analysts, it’s unlikely to jeopardise the dividend payout. And the sale of non-core consumer nutrition products, worth an estimated £2.5bn, can alleviate any immediate pressure on the dividend. 

Too cheap to pass up? 

So, for the time being, it looks as if Glaxo’s dividend is safe. It also seems as if the company’s growth is also set to receive a boost from the above deal. In other words, I believe that the deal with Novartis has offset the primary concerns hanging over the shares.

With this being the case, and considering the firm’s deep discount to the rest of the sector, I believe the GlaxoSmithKline share price is now too cheap to ignore.

Want To Retire Early?

Do you want to retire early and give up the rat race to enjoy the rest of your life? Of course you do, and to help you accomplish this goal, the Motley Fool has put together this free report titled "The Foolish Guide To Financial Independence", which is packed full of wealth-creating tips as well as ideas for your money.

The report is entirely free and available for download today, so if you're interested in exiting the rat race and achieving financial independence, click here to download the report. What have you got to lose?

Rupert Hargreaves owns shares in GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.