London-based pharma giant GlaxoSmithKline (NYSE:GSK) reported second-quarter earnings on July 29 that exceeded analysts' expectations. Earnings got a boost from assets acquired in a swap with Novartis (NYSE:NVS) that helped offset declining sales of the company's top-selling drug, Advair. Glaxo indicated that it's on target to deliver on its goal of a double-digit increase in core earnings per share in 2016. It also reiterated its dividend freeze and presented a sneak peek into its future drug lineup.
Quarterly sales rose 6% to $9.2 billion during the three months ended June 30 compared with the same period last year, reflecting the first full quarter that included the products Novartis previously owned. However, core earnings declined to 27.1 cents per share, a 9% decline from the same quarter a year ago. The drop was mainly due to declining Advair revenue and the loss of high-margin cancer drugs, which were swapped for less profitable vaccines and consumer products in the Novartis deal.
Glaxo's ViiV Healthcare, the company's AIDS and HIV business sector co-owned with Pfizer and Shionogi, was the bright spot, as growth in this sector far outpaced the pharmaceutical division.
The investing public liked what it heard overall, as the company's stock price closed up 2.18% the Wednesday after Glaxo reported its earnings.
Revenue from Advair, a daily maintenance medication that millions use to combat asthma, declined as a result of continued pricing pressure from powerful drug buyers such as Express Scripts. Advair lost its primary patent in 2010, and a secondary patent for the Diskus device is set to expire in 2016, after which the entry of generic biosimilars can be expected to decimate the drug's sales.
For the first half of 2015, Glaxo notched $1.37 billion in U.S. sales for Advair, down 19% from the previous year. Irrespective of the huge decline, Advair remains Glaxo's top-selling drug, and although sales declined year over year, investors may be able to breathe a little easier, as the drug's results exceeded expectations.
Results in line with expectations
In a deal originally announced in 2014, Glaxo swapped out its oncology drugs in exchange for Novartis' vaccines, and the companies established a joint venture for consumer health products, the effects of which are just becoming evident. Glaxo made the deal believing that it would be better off with the low-margin, higher-demand vaccines rather than high-margin, lower-demand cancer drugs, especially as powerful drug buyers place downward pressure on specialty drug prices. The company also envisioned that the Novartis deal would help smooth out its revenue distribution, thereby minimizing reliance on U.S. sales and enabling the company to balance its revenue among the U.S., Japan, Europe, and emerging markets.
Speaking about the effects of the Novartis transaction, Glaxo CEO Sir Andrew Witty said, "I think we're very encouraged by the progress that we've made." Sales growth in the quarter was largely due to the vaccines acquired in the Novartis deal and consumer-health products from the newly established joint venture. However, as anticipated, those lower-margin vaccines were instrumental in the 9% core earnings decline.
The next class of drugs
Declining revenue over the past few years and the company's stagnating share price have placed the company's CEO squarely in the hot seat. Witty is facing considerable pressure to deliver on his promise earlier this year of double-digit core EPS percentage growth that will fuel a significant recovery in 2016
Witty outlined a plan that could help Glaxo start heading in the right direction. The CEO focused investors on the company's pipeline of 40 new drugs -- including a forecast of $9.4 billion in revenue by 2020 from new pharmaceuticals and vaccines such as COPD drug Anoro Ellipta and type 2 diabetes drug Eperzan/Tanzeum, among others. In an unusual move for Glaxo, Witty presented the company's midstage pipeline of 40 new drugs, the vast majority of which were novel molecules rather than combinations of older medicines. Glaxo normally publishes only its late-stage phase 3 pipeline when presenting its financial results.
Witty indicated that 80% of the phase 2 drugs were the first of their kind and that the company expects to file about 20 of them with regulators in the next five years.
"This is the next class," he said. "They are going to generate substantial further growth opportunities."
It's not just about the dividend
Along with its earnings report and preview of upcoming drugs, Glaxo announced its normal $0.30-per-share quarterly dividend. Glaxo also reiterated its plans to return approximately $0.31 per share to shareholders as a special transaction, to be paid alongside the Q4 2015 ordinary dividend payment.
The company's current 6% annual dividend yield is inviting, to say the least. The yield is roughly three times that of the S&P 500 and approximately twice as much as dividend king and fellow pharmaceutical giant Johnson & Johnson currently yields. That said, Glaxo froze its dividend payout earlier this year, saying that while the annual payout isn't expected to be increased between now and the end of 2017, it also won't be decreased. I don't think the company's free cash flow easily supports the expected dividend payout, and I wouldn't be surprised to see Glaxo modifying its stance on the dividend and reducing the payout. Even if the payout was halved and the stock yielded 3%, it would still be a very satisfactory payout for investors; however, such action would almost certainly punish the stock price severely.
The overall takeaway is that Glaxo's second-quarter results were better than analysts expected. The company's portfolio of new drugs and vaccines, along with the newly-acquired products from Novartis, should support revenue, thereby lessening the impact of declining revenue from Advair. The company's stock is currently priced somewhat below fair value, in my opinion, and its sizable dividend, albeit temporarily frozen, remains quite tempting. Regardless, my desire is to only invest in companies currently selling at prices significantly below fair value. That's why, coupled with the uncertainty about future drugs, declining Advair sales, unexciting overall revenue, and a tenuous dividend situation, I'll be staying on the sidelines for now.