Source: GlaxoSmithKline.
In the pharmaceutical industry, GlaxoSmithKline (GSK 1.12%), the self-proclaimed "science-led global healthcare company", ranks among the largest companies by market capitalization. The London-based pharmaceutical giant is best known by the general public for such iconic consumer brands as Sensodyne toothpaste for people with sensitive teeth, denture adhesive Poligrip, and over-the-counter cold and flu medicine Theraflu. Consumer products aside, the company's primary source of income is derived from its prescription drugs and vaccines which account for nearly 80% of the company's revenue.
Good buy or good bye?
Glaxo has been in the news quite a bit of late. Some of the news has been good, including a rumored acquisition; some bad, including a decision to halt dividend increases for the next few years; some odd, including a Legionnaire's scare and a recall for wood in toothpaste; and some downright ugly, like a scandal involving bribery allegations in China.
With all of this press moving the company's stock price, sometimes dramatically, now seems like a good time to consider whether or not an investment in GSK is appropriate.
The good:
Novartis deal
In 2014, Glaxo and Novartis (NVS 1.13%), the Swiss-based pharmaceutical company, entered into a transaction wherein GlaxoSmithKline agreed to sell its oncology operations to Novartis in exchange for the Swiss drugmaker's vaccine division. The two pharma giants also formed a joint venture to market a number of consumer health products.
Glaxo's Q2 financial statements provided the first indication of what impact the newly obtained vaccines might have; Chief Executive Officer Sir Andrew Witty noted that 11 products, including two vaccines acquired in the Novartis deal, helped offset declining sales of Glaxo's best-selling respiratory drug, Advair.
Some feel that this was a bad deal for the U.K. pharma giant as it elected to part with its coveted oncology lineup. However, the transaction may ultimately help smooth out future revenue concerns as it shifts Glaxo away from prescription drugs and toward consumer products and vaccines, both of which are less susceptible to patent cliff issues.
Q2 earnings exceeded expectations
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 products previously owned by Novartis. However, core earnings declined 9% from the same quarter a year ago.
The drop was mainly due to declining Advair revenue and the loss of high-margin cancer drugs dealt to Novartis, but the quarter was bolstered by vaccines, including those acquired from Novartis. The company indicated that it's on track to deliver a double-digit increase in core earnings per share in 2016.
40 new drugs in the pipeline
The second-quarter earnings announcement also provided a glimpse into the company's future, as the CEO presented "the next class" -- the company's pipeline of 40 new drugs, 20 of which Glaxo expects to file with regulators within the next five years. Witty believes that these new drugs "are going to generate substantial further growth opportunities."
Malaria drug closer to approval
Every year, roughly 500,000 people die from malaria; but thanks to Glaxo, those numbers may be reduced. The company, which has been working on a vaccine to prevent this disease for 30 years, recently received a positive scientific opinion. This is a key step in the regulatory process, and one that goes a long way toward making this drug available for the prevention of malaria.
This development is not projected to have a material effect on Glaxo's financials, but it will likely improve the lives of those who live in areas affected by the disease. This is definitely good news for mankind.
Potential buyers
Glaxo has been a rumored acquisition subject for some time now with several big named pharmaceutical giants being mentioned as potential suitors, including Novartis, Johnson & Johnson, and most recently Pfizer. The merging of Glaxo with Pfizer would provide Pfizer with the London pharma giant's coveted COPD/asthma product lineup. While Advair, the cornerstone of this franchise, may be facing challenges, Glaxo still maintains the largest share of the global respiratory market -- a tempting plum for the acquirer. If this deal were to come to fruition, Glaxo shareholders will likely be amply rewarded.
The bad:
Dividend freeze
Earlier this year, Glaxo announced a freeze of its dividend payout through 2017, keeping the payout rate at the amount as of 2014. While not a dividend cut, wherein the dividend payout is reduced or eliminated, this was still bad news for many investors, especially those who rely on dividends and expect an annual increase as a component of their income stream.
It's not all bad news, however, as GSK shares still present investors with a hefty 5.6% dividend yield. Bear in mind though, if the company's purported turnaround does not come to fruition, a dividend cut in 2016 would not be a surprise.
CEO under scrutiny
Declining revenue during the past few years and inconsistent profits have put the company's CEO on the hot seat. Witty is under considerable pressure to deliver on his promise of double-digit core EPS percentage growth in 2016. If things don't improve quickly, there may well be a new person in the corner office.
Advair patent expiry
Revenue from Advair, a daily maintenance medication used by millions to combat asthma and COPD, declined recently as a result of continued pricing pressure from powerful drug buyers such as Express Scripts. Advair lost its primary patent in 2010 for the active ingredients in the medicine. However, a secondary patent for the Diskus device, the drug's delivery mechanism, isn't set to expire until next year. After this point, though, the barrier to compete with Advair will be lifted, and we can expect the entry of biosimilars to have a dramatic impact on the drug's sales.
Lack of late-stage blockbuster potential drugs
Witty gave us a glimpse into the company's future, presenting 40 drugs in earlier stages of development. However, Glaxo's pipeline lacks late-stage drugs with major blockbuster potential; consequently, the company's revenue will likely continue to be choppy.
"We have very interesting oncology assets in the pipeline," Witty said on a conference call with analysts. "Having missed the current wave, we're very pleased we'll be able to take part in the next wave." The company must have enormous confidence in its future oncology lineup, as it placed a huge wager on those drugs when it traded away its current cancer drugs in the aforementioned Novartis deal -- a move which raised more than an eyebrow or two. Optimism from the CEO aside, the loss of late-stage blockbuster drugs will likely end up negatively impacting revenue.
Cash from Novartis deal not distributed to shareholders
After announcing the Novartis deal, the company informed shareholders that it would distribute $6.3 billion as a special one-time dividend. However, later in the year, coinciding with the announcement to freeze its dividend, the management team at GSK reneged on that promise and reduced the expected capital distribution to just $1.6 billion, indicating that it is looking to maintain financial flexibility.
The odd:
Toothpaste: a new source of fiber?
Several years ago, our friends at LifeHacker.com demonstrated how toothpaste could be used to remove water marks from wood surfaces; they chose Senosdyne as their example. While toothpaste might be used to improve the appearance of wood, the inverse -- the appearance of wood in toothpaste -- generally doesn't improve the oral hygiene product.
Recently, GSK recalled nearly 4 million tubes of its Sensodyne and Biotene brands of toothpaste off retailers' shelves after finding that these products may contain small pieces of wood. The FDA report stated that there were "Fragments of wood found when the product was extruded onto a toothbrush." While the consumer products unit does not represent a sizable portion of Glaxo's revenue, such news may adversely impact the company's reputation.
Legionnaire's disease
A manufacturing plant that employs 850 people in North Carolina was shut down after routine testing uncovered Legionella, a bacterium related to Legionnaire's disease, in two external cooling towers. GSK's stock price declined by more than 1% when the news of the closure was released, as investors feared an extended delay in production of Advair.
Normal production resumed a few days later after the plant was cleaned and disinfected. This issue was resolved quickly, mitigating what could have been a much more serious situation.
The ugly:
China scandal
Undoubtedly, the most humiliating news story for this U.K.-based pharma giant took place last year when the company was found to have been involved in a bribery scandal in China, in which it was accused of having made an estimated $150 million in illegal profits. The scandal resulted in settlement fines of nearly $500 million, along with suspended jail time for some of the company's top executives.
An internal investigation into the scandal resulted in the dismissal of more than 100 employees in China. Regardless, there's no quick fix here for GSK as it attempts to rebuild its battered brand in a country with the world's second-largest economy. The effects will likely impact the company for some time.
Am I buying?
In a word, no. Things may be looking up a bit for Glaxo as a result of better-than-expected earnings in the most-recent quarter, a potential suitor, and a dividend yield that tempts more than ice cream on a summer's day, but there's too much uncertainty surrounding the company's future. There are big question marks about the company's earnings, its drug pipeline, the impact of generic competition on Advair, and the frozen dividend, which I believe has a reasonable chance of becoming a dividend cut. For my taste, the uncertainty outweighs the potential; therefore, I'll pass on Glaxo at this time.
