FTSE 100 pharma giant GlaxoSmithKline (LSE: GSK) is heading for a break-up. Chief executive Emma Walmsley will oversee the creation of two companies — a focused and faster-growing pharmaceutical company and a profitable, stable consumer healthcare business.
This strategy isn’t a sure thing, but I think there’s a good chance it will work. Today I’ll explain why. I’ll also take a look a FTSE 250 stock which I think offers an interesting mix of opportunity and risk.
A break-up makes sense
In the past I’ve been a supporter of Glaxo’s conglomerate structure. This combines mature consumer products such as Panadol, Nicorette and Sensodyne with cancer treatments and other pharmaceuticals.
But this hasn’t worked out well. The group’s performance has stagnated for years and its shares have lagged the FTSE 100. In the meantime, debt levels have risen.
After less than two years in the job, Ms Walmsley has secured a deal to merge the firm’s consumer healthcare business with that of US pharma rival Pfizer. The resulting joint venture is expected to become a standalone business within three years.
One big advantage for Glaxo shareholders is that a sizeable part of the group’s £22bn net debt is likely to be carved out into the new consumer business. This will leave the pharmaceutical business with a stronger balance sheet and more flexibility to invest in new growth opportunities.
Too good to be true?
You could argue that this is all just financial engineering, designed to disguise the fact that Glaxo has too much debt and is due for a dividend cut.
The reality is that we won’t know how well the split will work for another few years.
In the meantime, I’m happy to give Ms Walmsley the benefit of the doubt. Although I don’t think that GlaxoSmithKline is the bargain of the year, I do think that the group’s 5.3% dividend yield remains attractive for income investors.
How will this story end?
FTSE 250 cinema chain Cineworld Group (LSE: CINE) has been one of the stock market success stories of recent years. The firm’s shares have risen by 118% in five years and are up by 6% at the time of writing.
The twist in this story is that Cineworld splashed out $5.8bn on the acquisition of US rival Regal Entertainment last year. This has transformed the UK firm into the second-largest cinema chain in the world.
Results published today show that the combined group’s revenue rose by 7.2% to $4,711m last year, while its adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) rose by 9.4% to $1,0722m. Both figures are calculated as though the two companies had always been combined.
This ambitious acquisition is expected to generate cost savings of $150m in 2019. But this deal has also left Cineworld with net debts totalling $3.9bn. That’s equivalent to about 3.7 times adjusted EBITDA. That’s well above my preferred maximum of 2x EBITDA.
Today’s numbers suggest to me that reducing debt to a more comfortable level could take three to five years. In my view, a dividend cut would be prudent to speed up this process. Instead, the 2018 payout will be lifted by 15%.
Cineworld shares now trade on about 12.5 times 2019 earnings, with a forecast yield of 4.6%. Given the group’s debt level, I’d say the shares look fully valued. I’d hold.
