GSK is being nursed back to health

Last September in a review of the pharmaceutical industry I concluded that GlaxoSmithKline (GSK) shares were discounting too much bad news and not enough future potential. Pharmaceutical shares are admittedly a speculative thing, the nature of which regulatory advice constantly warns us.

However, all investment involves speculation about the future. If it were any different, there would be no speculative profits to be made. All investment judgements are based on some degree of speculation. The facts can take you so far but not as far as a totally solid, wholly factually based conclusion. Investment is like crossing a stream on a broken footbridge that doesn’t quite reach the bank on the other side. To reach that you always need to make a well considered leap. Equity investment is full of broken foot bridges. The art of it lies in the consideration surrounding whether to leap or not. That is true even of long term businesses like pharmaceuticals which lie above the normal economic cycles of trade winds.

In the case of long term drug development companies, the behaviour of the share price is instead buffeted by the winds of news flows about their progress. GlaxoSmithKline has just released some positive bits of news. When a share price is as depressed as that of GSK, such news tends to blow the share price upwards, as it has done on this occasion.

First, the market was cheered up to learn that a post marketing test of ADVAIR DISKUS an anti asthma cocktail of a treatment, was in fact safe for patients as a combination of treatments. The FDA will review the report and hopefully agree.

Second, the company has done work which demonstrates that its vaccine for the treatment of shingles in the over seventies is clinically efficacious. Regulatory authorities demand evidence that these things actually work sufficiently well to do people sufficient good.

There was also efficacy and safety data released on two other products in development INCRUSE and ELIPTA which was also positive and hopefully will impress the FDA with its conclusions.

In addition Q3 sales were up a reported 9%, a smidgen better than the number estimated by the institutional analysts. In the sales mix there was a super-normal rise in the sales of HIV products which reportedly rose 65%. Vaccine sales also did well with a near one third increase in demand.

The significance of such news is to be seen when set against the fall in the company’s previous champion, blockbuster respiratory therapies, Advair and Seretide, which are off patent and in decline. The good news is an indication that the company’s strategy is working; that is to say, adopting a policy of selling lower value drugs in higher volume, rather than keeping on the lonely trail of trying to find the next big blockbuster. That is a risky objective when too much hope is put in one basket, along with those proverbial eggs. That is an alternative to a break-up of the company. Having underperformed over recent times, the shares jumped 4% to reach 1,420p before profit taking trimmed them back to 1,403p.

So where do we go from here? The company is now three quarters though a reported 2015, the year ending this coming December 30^th. Clearly more good news of this kind is required to give the shares the expectation of long term progress. Failure in that department, would be dreadful to contemplate for this £69 billion market cap company which had in it last annual balance sheet,  enough debt to gear its net assets a reported 252%, giving the whole enterprise a decidedly speculative high risk profile; hence the high dividend. In that regard, I am pleased to see that the management have evidently been persuaded to reduce the cash giveaway to shareholders (from a business sale proceeds to Novartis) from £1.4 billion to £1.0 billion. This is a major British company of peculiar importance to us all which should retain such cash in the business to reduce balance sheet gearing, returning it to shareholders at a later date when the strategy is more fully working and operational cash is closer to normality. Paying it out is an example of the ‘greenmail’ of short term, contemporary, financial market, casino capitalism, which is breathtakingly regrettable. It will only add to the Glaxo’s problems.

The question is whether the shares still look bombed out enough to be attractive to responds to further good news and to weather poor news, as it has done in recent times.

On the 29^th of September, the share price bottomed out at 1,227p so it is 14% off the bottom; arguably not a lot for a particularly depressed share like GSK. The chart shows a clear break out from its most recent downtrend and will bear the chart interpretation of it possibly reaching 1,600p on its continuing longer term downtrend. Have a look for yourself to see if you agree.

If sales do start to pick up then the dramatic equity gearing of 252% will start to work in the share’s favour; this is one of the factors that makes GlaxoSmithKline shares a notably attractive speculation at this stage. Last year’s sales are valued at about three times at the current price.

Although the balance sheet contains no tangible assets because of goodwill and intangibles, it represents a lot of intellectual property. The June 30^th balance sheet stated conventional accounting balance sheet assets as worth about 10% the 1,403p share price.

Operating cash on June 30^th was well up on the March figure but only about one tenth of that reported in December.  Year end balance sheet cash in June was however significantly up on the December figure.

Finally, the historic annual dividend (80p a share) yield is still 5.7%, although the historic price to earnings multiple (on a reported and very depressed earnings per share of 57p) is 24 times. However, the market in its consensus estimates is more positive with a 16 times multiple of next year’s estimated, improving earnings and a normal estimated annual dividend yield of 6%.

Taking all of the aforementioned into account, my personal reaction is to remain bullish in the expectation the shares will approach 1,600p on improving news from the company. This is an attractive high dividend speculative situation.