Big blue-chip drugmakers like GlaxoSmithKline (GSK -0.92%) have been under pressure as the patent cliff cuts deeply into revenue and profit.
Across the entire industry, more than $100 billion worth of branded drugs will have lost patent protection between 2013 and 2015, and that patent headwind has already forced Glaxo's sales to slip from more than $46 billion in 2010 to $41 billion in the past 12 months.
The sagging sales have taken Glaxo's shares down 8% this year alone, but with cost savings tied to a major restructuring, new products, and an enticing 5.3% dividend yield, is now a good time to buy?
Source: GlaxoSmithKline.
First, a bit of background
Glaxo relies heavily on the asthma market, where its Advair Diskus is a top seller that notches $8 billion in annual sales globally.
But while Advair diskus is one of the planet's top-selling drugs, it's also a big risk to Glaxo investors. That's because Advair accounts for an an eye-popping 20% of Glaxo's revenue, and its sales have been falling.
As competition has heated up in the space, payers are pushing back on pricing. As a result, U.S. sales of Advair have tumbled 21% year over year in the first six months of 2014. Even more discouraging, that sales drop has come from both falling prices and lower volume -- a double whammy that no shareholder wants to see for a company's most important drug.
Unpleasant as the sinking sales may be, the competitive threat to Advair pales in comparison to the threat of a potential generic version of the drug. Advair lost U.S. patent protection in 2010 and EU protection in 2013, yet generics have yet to emerge thanks to patents still covering Glaxo's diskus inhaler. However, those diskus patents are set to expire in 2016, and while it's unclear whether generic drugmakers will be able to create a copy similar enough to Advair to derail its sales, the impact of the potential threat could be significant.
As a result, Glaxo is waist-deep in a restructuring that has shaved $700 million in annual R&D costs since 2010 and has reduced its annual operating expense from over $20 billion to roughly $17 billion a year.
Turning a corner
Even with the cuts in spending, Glaxo remains one of the most active drugmakers in terms of R&D, and that suggests it could have a slate of new products coming to market over the coming years that could diversify it from Advair.
For example, Glaxo's Breo and Anoro have recently won FDA approval, and analysts think those two respiratory drugs could have multibillion-dollar potential because Breo will sell into a global market worth more than $13 billion, and Anoro will compete in a market worth nearly $8 billion.
Source: GlaxoSmithKline.
Glaxo's Tivicay could also help fill the void. Glaxo's HIV consortium, ViiV Healthcare, won approval for Tivicay last fall, and Tivicay has already captured 11% market share among treatment naive HIV patients. That share translated into Tivicay sales of $104 million during the second quarter. Glaxo may also see sales of its recently approved combination HIV drug Triumeq grab share. During clinical trials, Triumeq, which combines Tivicay with two older HIV medicines, outperformed Gilead's $3.6 billion-a-year Atripla.
Debating valuation
Although Glaxo is forecasting that earnings should prove similar this year to a year ago, doubts over 2015 have the company's forward price to earnings ratio near five-year highs. Valuation relative to its historical levels is stretched, but may not be too far out of whack considering that forward P/E ratios at both Merck and Johnson & Johnson are higher.
However, Glaxo's price to sales ratio isn't that attractive, either. The measure has fallen from its recent peak and is below pre-recession levels, but it's far from flashing a gotta-buy signal.
GSK PS Ratio (Forward) data by YCharts.
Tempting, but...
Although it's hard to fault long-term dividend investors for taking a stab at GlaxoSmithKline given its handsome yield, I want more insight into the potential generic threat to Advair and whether or not new drugs like Breo, Anoro, Tivicay, and Triumeq can stem the sliding sales before I commit to buying.
