The big-cap pharmaceuticals have been taking hits to their revenue as patents for a number of the biggest-selling drugs expire. This has led to investors questioning whether the likes of GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) can maintain their generous dividend payouts. What’s going to drive their future revenue?
Fundamental to this is a reinvigorated drugs pipeline. GlaxoSmithKline has been dedicating time, cash and attention to pipeline development, which should bear fruit in the future.
Much of the company’s revenue comes from its vaccine portfolio, contributing $4.1 billion for the first nine months of 2013, or 16% of total revenue. The aim is to build a stronger vaccine portfolio and to do this the company is developing new molecules and enhancing the efficiency of its current vaccines.
Investing for the future
Good quality R&D is crucial, and while full of challenges, can’t be overlooked. Some analysts have stated that investment in research is an inefficient way to use a company’s money. Given that research is often unsuccessful, these analysts believe that ‘in-licencing’ is more efficient, which is bulking up the pipeline through outside sources.
True, R&D is expensive and investors in dividend stocks like to see a massive cash flow maintained to cover payouts. My belief is that that is short-termist. If you invest you’re investing for the future, which isn’t three to six months but five or more years. Long term you’ll reap the rewards.
New opportunities
GlaxoSmithKline has successfully developed the world’s first malaria vaccine — RTS,S — in collaboration with Agenus. To date it has invested $350 million and is planning to invest another $260 million to develop RTS,S as a complete vaccine to prevent malaria in young children and infants.
Now GlaxoSmithKline doesn’t set itself a fixed R&D budget. Instead of a budget, to be mindlessly tossed away, it views R&D much like you view your shares — as an investment. But were we to take its last published R&D numbers, for 2012, the $600,000 million spent on this new malaria drug doesn’t seem quite so eye-popping.
True it’s not an insubstantial amount, but realistically, purging the company’s R&D division won’t result in a windfall for shareholders (but there will be tears when the pipeline dries up).
For a chance to grab the majority of the malaria vaccine market the R&D expenditure makes sense. Again, look at it like an investment.
Valuation
Taking into account its strong drug portfolio, including its leading vaccines and the potential profitability of the malaria market, GlaxoSmithKline’s long-term growth prospects look good. Through a combination of pipeline production and cost cutting, earnings per share look set to go up.
It also has a dividend yield (4.5%) that outstrips the FTSE 100 average. Dividend growth has been robust over the past few years and the current yield is supported by a strong free cash flow.
Overall you get the best of both worlds.
