GlaxoSmithKline Stock Could Finally Be Turning A Corner (NYSE:GSK)

For years, GlaxoSmithKline (OTCPK:GLAXF) has been maintaining a mix of stagnant performance, high dividend yield, combined with a strong financial position that compares more with regulated utilities than with volatile pharma groups. The long-standing former CEO, Andrew Witty, who was at the helm for 8 years could not change it, and high hopes were on Emma Walmsley when she took over five years ago. Ms. Walmsley was head of the consumer healthcare sector – she was neither a scientist not a former CFO, which is often the profile of CEOs of healthcare companies. Investor criticism has not been in short supply of Ms. Walmsley since she took over. Also, she was hyperactive in restructuring GSK through M&A and management changes since she took over, financial performance and the share price had nothing to show for it.

More recently, large shareholders have been even asking for the resignation of Ms. Walmsley or that she returns to her consumer healthcare role, by heading the spun-off company. Despite serious pressure, she stood firm and resisted such calls. She may be finally vindicated.

Is the genie finally leaving the lamp?

After another mediocre year in 2021, GSK’s performance in Q1 2022 has stood out from the former years of stagnation. Sales revenues remained stagnant between 2019 and 2022, and operating profits actually declined between 2020 and 2021. But Q1 2022 saw sales increasing by an impressive 32%, and operating profits increasing by double that rate, at 65%. EPS almost doubled with a 43% increase. What is important is that this impressive growth has been broad based across the different businesses. Biopharma specialty medicines grew by staggering 97% in total (15% excl. Xevudy), vaccines by 36% and consumer healthcare (soon to be spun off) by 14%. General medicines is the laggard category, growing by only 3%.

The listing of the consumer healthcare business is on track

The consumer healthcare business (named “Haleon”) is in good shape and on track for the planned listing. Sales growth over the past year has mainly been volume driven – in total growth of 14% was driven by 13% growth in volumes and mix changes, and only 3% growth in prices. As faster price increases will be essential to cope with inflation, the business has a good base to continue growing sales with double digit rates – having already a strong base of volume growth.

GSK is set to hold a general shareholders’ meeting on the first of July for voting on the demerger, with the plan for the demerger, and Haleon’s public listing, to be effective later in July – subject to market conditions. Following the demerger, GSK will still own directly 13.5%, while existing GSK shareholders will own 54.5% – the balance owned by GSK’s partner in the business, Pfizer.

The exact value of the listing of Haleon is still to be seen – reports indicated a wide range between GBP 40 billion and GBP 60 billion over the past few months. Given that GSK rejected Unilever’s acquisition offer of GBP 50 billion for Haleon in January, a listing of Haleon for anything less than GBP 60 billion would be destructive for shareholders’ value. GBP 60 billion though would value the Haleon at 33 times annualised Q1 2022 net income, and whopping 43 times operating cashflow of 2021. Given that GSK’s total market cap today is GBP 88 billion, it means that the pharma and vaccines business, which contributed more than 75% of adjusted operating income in 2021 versus 25% for the consumer healthcare business, will be only valued at GBP 47 billion – 54% of the total value of the business – while Haleon’s 68% share that is owned by GSK will be worth GBP 41 billion for GSK’s shareholders. Haleon will also start its new life with a massive net debt to operating cashflow of 6.6x.

If GSK manages to pull off the demerger at GBP 60 billion Enterprise Value (including GBP 10 billion debt), then this would be massive win for GSK’s shareholders, and a final vindication for Emma Walmsley. It will help indeed to unlock significant value. Given how markets have turned in the past six months, it will be a big question mark if investors would be ready to pay these excessive valuations for Haleon. Most likely GSK will either need to postpone the listing or to sell cheaper. GSK would risk that the listing is a major failure, otherwise. But GSK’s management and board have put themselves, unnecessarily, between a rock and a hard place. Unilever’s bid seems now that it could have been a profitable one for GSK’s shareholders (although not for Unilever’s). Now that GSK lost the chance to offload Haleon to Unilever at an appealing valuation, they have missed the train, and this is likely to backfire even further to GSK’s already embattled CEO.

For GSK’s current investors, Haleon’s shares on a stand-alone basis would be destined to face a downward spiral if listed at an excessive valuation. But even if a more reasonable valuation is reached by listing time; the fact that Pfizer announced it plans to exist its 32% stake when listing would lead to a significant downward pressure on the share price in its first few months.

Future is promising

GSK’s management expect full-year 2022 to witness 5-7% sales growth, with 12-14% adjusted operating profit growth. Given the outstanding performance in Q1 2022, there is good reason to believe that these expectations could be, not only achieved, but easily beaten.

The company has focused well on building its pipeline of 64 vaccines and medicines, 21 of which are in pivotal studies, out of which 11 medicines are hitting Phase 3 approvals this year or next year. This a slight improvement to Q1 2021 when GSK had a pipeline of 59 vaccines and medicines, 21 of which were in pivotal studies.

To accelerate growth and focus on the pharma business, GSK has been using its financial power to make key acquisitions. In April 2022, it acquired Sierra Oncology for USD 1.9 billion, a biopharma company focusing on developing treatment for rare forms of cancer. And last month, GSK acquired another biopharma, Affinivax, for USD 2.1 billion plus another USD 1.2 billion linked to potential milestones. Affinivax is focused on developing vaccines for pneumococcal disease includes pneumonia, meningitis, bloodstream infections and other milder infections. Both acquisitions fit well with GSK’s focus on cancer medication and on strengthening their leadership in vaccines.

The demerger would strengthen GSK’s finances even further, and would allow more acquisitions on pharma to come. GSK enjoys a strong credit rating of A, and liquidity is plentiful.

Investors should keep an eye on those risks

The potential demerger from the consumer healthcare business will change the shape of GSK drastically. Some investors would have taken comfort from the relative stability and predictability of the consumer healthcare business that balanced the typical ebbs and flows of the pharmaceutical businesses, which is accompanied by the cyclical movements of their drug pipeline. When a pharma company finds a blockbuster drug, that drug can lift its performance drastically for a certain period of time. Pfizer is the most recent example with its COVID-19 vaccine, and before it there was Gilead with its Hepatitis drugs, and so on. But then such blockbuster drugs start losing patent protection, and the pricing power of their parent companies starts to fade, leaving financial performance vulnerable and the need for other blockbuster drugs arise. And so on. Consumer healthcare products, on the other hand, maintain a stable, low, or medium level of growth, accompanied with more subdued profit margins. But the business is more stable and balances out the cyclicality of the patented drugs business. Losing the consumer healthcare business will expose investors to this multi-year cyclicality.

Innovation, or the lack of it, has been also one of the weaknesses of GSK. GSK’s poor record on innovation was demonstrated clearly in its slow response to the search for a COVID-19 vaccine, and it will remain an obstacle and a red flag for investors. The improvement of advanced drugs pipeline helps to reduce the concerns, but success will be measured by final approvals and sales performance of new drugs.

Valuation and market entry

The past year provided handsome returns for shareholders; 25% share price growth, excluding dividends. The share price finally jumped out of its previous tight range and outperformed the FTSE 100 by a good 22%. GSK’s improving performance has been key, and investors’ confidence has raised the overall valuation parameters. Today, GSK trades at 17 times P/E versus 14 times one year ago. This is still well below peers, giving GSK still an attractive valuation entry point. UK peer AstraZeneca recorded net losses in 2021 yet its market cap is GBP 150 billion versus GSK’s GBP 88 billion. Denmark’s Novo Nordisk trades at 37 times. And the revised dividend yield of GSK in 2022 at 3% today’s share price is higher than the 1.3% of Novo Nordisk and the 2% that you can get from AstraZeneca today.

GSK is undergoing a massive transformation in its corporate shape. Its defensive qualities are changing by letting go of the consumer healthcare business and trying to accelerate growth and profitability through innovative medicines. Conservative investors who would be looking at the full half of the cup would keep GSK in their portfolios based on the decent valuation, strong financial position, decent dividend yield, and prospects from big upside through product development and M&A activities.