British healthcare giant GlaxoSmithKline plc (NYSE:GSK) embarked on a major restructuring when it announced a multipart deal with Novartis AG (NYSE:NVS) in 2014. The agreement involved swapping Glaxo's current portfolio of oncology drugs for most of Novartis' vaccine assets, and it also created a consumer healthcare joint venture that combined the consumer assets of both companies. The deal closed in March 2015, so we've had six quarters to see results, and two quarters to compare year-over-year numbers for the new structure -- and so far, the numbers say the deal is working.
Sales of newly developed products are accelerating
Some analysts were surprised GSK would divest its fast-growing and profitable oncology drugs and were concerned that the company would hurt its growth in the long term. Glaxo's rationale was that it would be able to use part of the $16 billion cash proceeds and $5 billion dollars of annual savings to reinvigorate new product development.
We won't be able to fully judge the success in this area for several years, but the early results are impressive. Sales of products developed in the last three or four years have grown dramatically since the deal closure.
|Quarter||New Product Sales||Percent of Total Sales|
|Q2 2015||$687 million||8%|
|Q3 2015||$904 million||10%|
|Q4 2015||$1.043 billion||11%|
|Q1 2016||$1.174 billion||13%|
|Q2 2016||$1.481 billion||16%|
|Q3 2016||$1.609 billion||16%|
The top-of-mind concern for shareholders has been the patent expiration for blockbuster asthma drug Advair and the anticipated release of a generic equivalent. In fact, pricing pressures on the drug, which had accounted for $8.84 billion of revenue in 2013, have caused sales to absorb half of the impact of genericization already. In spite of this drop-off, pharmaceuticals grew 6% year over year last quarter on a constant-currency basis. Since the Novartis deal, continued losses in Advair sales have been more than compensated for by growth in more recently developed products.
The vaccine business is leading sales growth
Glaxo's business consists of three segments: pharmaceuticals, vaccines, and consumer products. A major objective of the restructuring is to achieve better balance between the three segments by bolstering the vaccine and consumer businesses. The pharmaceutical business has plenty of risk due to failed trials, patent expirations, pressures on pricing, and of course, intense competition in some of the most promising growth areas. The vaccine and consumer businesses are steadier, "annuity-like" businesses, in the words of management, that form a counterweight to the risks in pharma.
The early results from the new vaccines business since the Novartis deal have been excellent. At the time of the deal announcement, the revenue of the combined vaccine businesses were projected to comprise 14% of Glaxo's total. In the first four quarters after the deal closure, vaccine sales were up to 15.7%. In the most recent trailing 12 months, that proportion was up to 16.6%. Year over year in constant currency, vaccine revenue was up 11% in Q2 and 20% in Q3, although the latter was boosted somewhat by seasonal flu vaccine shipping earlier than last year.
Vaccines should continue to be a substantial growth engine for the company, as the meningitis portfolio acquired from Novartis is experiencing unexpectedly high demand and is temporarily limited by production. And next year, we should see the new shingles vaccine that will eventually add a billion dollars to revenues. Growth is strong in pneumococcal and the new quadrivalent flu vaccines, as well.
Consumer margins are improving
The new consumer business is growing, with year-over-year revenue gains of 5% last quarter and 7% the quarter before in constant currency. But more importantly for the overall business, margins have been improving. In the first 12 months after the formation of the consumer subsidiary, operating profit margin was 12.5%. In the most recent 12 months, that margin has improved to 14.9%.
Consumer CEO Emma Walmsley, soon to take over as CEO of GSK, has focused on key brands, taken cost out of the supply chain, and plugged newly acquired products into Glaxo's global marketing and distribution machine. The result is that the new consumer subsidiary contributed 28% more operating profit in the trailing 12 months than it did in the year ending six months ago.
Profits and cash flow are growing
Headline numbers for the company mask some of the real progress made, due to the drastic movement in the value of the British pound after Brexit and the various charges and changes related to restructuring. But pro forma numbers for the core business in constant currency terms are showing us that the strategy is working. Pro-forma, constant currency results for the first nine months of 2016 show that core operating profit was up 18% compared with the equivalent period the previous year, and operating margin increased by 4.4 percentage points. Operating cash flow tripled in dollar terms from $1.63 billion to $4.87 billion.
Results six quarters into the major restructuring of the company are encouraging. Investors who own the stock for its rich 5% yield should be heartened by the company's commitment to its payout through 2017 and the potential to see the dividend increase after that. Growth investors should also start paying attention to the emerging signs that the new structure will be producing steady growth into the future, and that the stock is valued at only 15 times consensus earnings for 2017. For a conservative portfolio, some shares of GSK might just be what the doctor ordered.