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Why I’d still buy FTSE 100 giant GlaxoSmithKline but avoid this growth stock

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E-invoicing firm Tungsten  (LSE: TUNG) processes invoices for 67% of the FTSE 100 and 76% of the Fortune 500. Its platform “maximises efficiency and improves cash flow management” for such giants as General Motors, GlaxoSmithKline  (LSE: GSK) and IBM, as well as other organisations, including the US Federal Government.

All about cash flow

In a trading update today, for its financial year ended 30 April, Tungsten said it processed transactions worth over £160bn and generated record revenue. However, compared with the value of the transactions, revenue was tiny at £33.7m. A 9% increase (at constant exchange rates) on the prior year is not particularly impressive and it was below expectations of £35.5m.

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Historically, the company has been lossmaking and a serial disappointer, even on its favoured and most generous measure of profitability, EBITDA, which it defines as “operating loss from continuing operations before other income, depreciation, amortisation, share-based payments charge, and exceptional items.” It said it expects its EBITDA loss to narrow to £4.6m from £11.8m, adding that EBITDA turned positive for the final four months of its financial year. It didn’t enlighten us as to cash flow in those final four months but said net cash outflow for the whole year was £11.1m.

Tungsten has taken to capitalising development costs in the last couple of years. This practice has a positive effect on paper earnings but not on net cash flow. The company capitalised £3.6m in fiscal 2017 and £2m in H1 fiscal 2018. We’ll have to wait for the full results in July to get a real picture of how the cash flowed and an idea of whether remaining cash of £6.4m at 30 April provides the business with adequate resources. For the time being, I’m minded to avoid this AIM-listed stock, whose shares are currently trading 3.3% down at 53p, following today’s update.

Improving outlook

GlaxoSmithKline’s shares were trading at 1,350p near the start of the year when I saw great value in the stock. At that time, the forward 12-month price-to-earnings (P/E) ratio was 12.3 and the prospective dividend yield was 6%. The shares have climbed to a current 1,530p with the P/E up to 14.1 and the yield down to 5.2%. Nevertheless, as the P/E is around the level of the historical average for the FTSE 100 as a whole and the yield is above average, I still see value here and continue to rate the stock a ‘buy’.

In its annual results released in February, Glaxo reported improvements in sales, margins and cash flow in 2017. All three of its businesses — Pharmaceuticals, Vaccines and Consumer Healthcare — delivered sales growth. There was similar across-the-board growth (at constant exchange rates) reported for Q1 this year in April.

I was also encouraged that the company declined to bid for the consumer health business of Pfizer at a mooted $20bn and instead struck a $13bn deal with Novartis to buy the 36.5% stake in their consumer health joint venture that it didn’t already own. This transaction has just completed and will boost Glaxo’s future cash generation and support the group’s main priority of strengthening its Pharmaceuticals business and R&D pipeline. I believe investors can look forward to a new phase of good earnings and dividend growth over the medium-to-long term.

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G A Chester has no position in any of the shares mentioned. 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.

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