Three weeks ago, U.K.-based pharmaceutical giant GlaxoSmithKline (NYSE:GSK) reported its third-quarter results and handily clobbered Wall Street's profit projections, to the surprise of many.
For those who may have missed it, GlaxoSmithKline reported nearly $9.4 billion in revenue during the third quarter, which excludes negative currency movements, translating into growth of 11% from Q3 2014. Please note that Glaxo reports in British pounds, so the translation to U.S. dollars can impact the perception of how well or poorly it fared during the quarter.
Profits, though, dipped to $2.62 billion on a constant currency basis, or $0.35 per share. Comparatively, though, Wall Street had only been expecting the company to deliver a profit of $0.30 per share. GlaxoSmithKline also stuck to its projection of double-digit percentage EPS growth in 2016 and an 80-pence dividend for the full-year.
Five things GlaxoSmithKline's management wants you to know
The strength of Glaxo's report caught many investors by surprise -- but it still doesn't tell the full tale. In order to get a truer glimpse into the long-term health of the company's business model we need to comb through the company's quarterly conference call to pick out the most important nuggets of wisdom. The following five points are the most important things you as an investor should be taking away from GlaxoSmithKline's conference call.
Our cost-cutting is going as planned
"We're on track or slightly ahead of our plans [for cutting costs] and have delivered total incremental savings in the first 9 months of this year of over GBP 700 million compared to the same period last year, GBP 300 million of that in the third quarter alone." -- Simon Dingemans, CFO
It's no secret that GlaxoSmithKline is having growth difficulties as a direct result of falling Advair/Seretide sales. Advair (known as Seretide in overseas markets) is the company's blockbuster inhaled COPD and asthma therapy, responsible for more than $8 billion in annual sales at one point. This year Advair sales could come in below $5 billion as pricing pressure around the globe weighs on the drug -- and all the while the drug's key patent is staring down expiration next year.
With its respiratory portfolio weighing it down, Glaxo has pursued multiple avenues to cut costs. The company's asset swap with Novartis (NYSE:NVS), which sent its oncology franchise to Novartis in exchange for Novartis' vaccines franchise (excluding flu) and cash, also resulted in the two forming a joint-venture in their consumer health products franchises. This tie-up and elimination of redundancies should lead to approximately $1.5 billion in savings. Additionally, supply chain restructuring, and a restructuring of its pharmaceutical business, could net billions more in cost-savings.
Glaxo's commentary would suggest that its cost-savings are right on track, which is important for a company looking to demonstrate EPS growth despite declining Advair/Seretide sales.
Mind the currency moves please!
"Currency movements were a 2% drag on sales and a 5% headwind on core EPS. If rates remain at the same level as at the end of the quarter and we have no further intercompany settlement gains or losses, we would expect the year as a whole to see also a 5% negative currency impact on core EPS." -- Simon Dingemans
GlaxoSmithKline's management team, just like that of any large multinational pharmaceutical company, wants investors to understand that you have to dig past the headline revenue and profit figures to get a better glimpse of how well a business is performing. CFO Dingemans notes that currency translation has been adversely impacting the company's sales and profits, but that excluding these currency movements GlaxoSmithKline is performing substantially better.
Of particular interest, Glaxo is quick to point out that its HIV franchise grew by an exceptional 65% during the quarter from the prior-year period, its consumer health joint-venture delivered 55% constant currency growth (helping Novartis as well), and vaccine sales advanced 32% on an operational basis. Focusing on theses apples-to-apples comparison certainly gives investors a potentially brighter and more accurate outlook for the company.
Expect respiratory to improve in 2016
"We expect the pulmonary coverage in 2016 for all of our Respiratory products to be as good as or better than in 2015." -- Simon Dingemans
GlaxoSmithKline's next-generation respiratory portfolio has been a bit disappointing to say the least. Breo Ellipta, the first of four recently approved long-lasting respiratory products, took a while to gain coverage with insurers, who balked at its wholesale cost. More recently, Glaxo warned investors that Anoro Ellipta may face growing pains as it attempts to infiltrate a market that's dominated by Advair and Spiriva.
What Glaxo's management team wants you to know is that insurance coverage for its four next-generation respiratory products should be less of an issue next year. This isn't to say that insurer coverage for Breo, Anoro, Incruse, or Arnuity is anywhere near where GlaxoSmithKline wants it to be. Obtaining coverage is still an uphill battle considering that generics for Advair/Seretide could be entering the market at any moment. However, broader insurer coverage should ultimately lead to sales growth in the respiratory franchise.
Here's why we struck a deal with Novartis
"You have a business, where there is no material intellectual property rights threat to the company's portfolio until 2026, 2027, and a business which has, in all 3 of its platforms, very significant opportunity to grow at what would be very material margins by that point." -- Andrew Philip Witty, CEO
The Novartis-GlaxoSmithKline asset-swap was an eye-opener on Wall Street, but it left some investors wondering what GlaxoSmithKline was thinking. With the deal GlaxoSmithKline gave up its potentially fast-growing oncology franchise in exchange for a vaccine division that was almost certain to hurt its margins. During the conference call Glaxo's CEO helped explain a key point of the deal that you may have missed.
As noted by Andrew Philip Witty, the transformation of GlaxoSmithKline will keep the company largely protected from generic competitors for the next decade. Over that period the introduction of new products, combined with improved efficiency (the aforementioned supply chain and pharmaceutical operations restructuring), should allow its margins to expand and its profits to grow.
That's certainly one way to beat the patent cliff!
Down but not out with Breo
"SUMMIT was never in any of our forecasts that we shared with the street. So for example, when we said that we would deliver at least GBP 6 billion of new product sales by 2020, that did not include a SUMMIT. Actually, since the introduction -- since the launch or since the news of SUMMIT, we see no adverse effect on Breo." -- Andrew Philip Witty
Finally, GlaxoSmithKline investors were shaken to the core when it and its development partner Theravance (UNKNOWN:THRX.DL) announced in September that the SUMMIT study, which was examining Breo in COPD patients with limited airflow and either a history or increased risk of cardiovascular disease, didn't meet its primary endpoint of improved overall survival. While there was a slight trend in favor of patients taking Breo in terms of overall survival, it was not statistically significant. Glaxo and Theravance had been counting on a survival benefit to boost sales of Breo.
However, Witty pointed out during the call that while disappointed in the failure of Breo to extend overall survival in SUMMIT, it doesn't appear to be having a materially negative impact on sales of the drug. He also notes that Glaxo's estimates calling for roughly $9.1 billion in sales from new therapies by 2020 didn't include the possibility of SUMMIT succeeding. In other words, Glaxo wants its shareholders to know that even with SUMMIT's failure, Breo and its next-generation respiratory products are still expected to be blockbusters.
What now for GlaxoSmithKline?
Now that we've had a closer look at the key points from GlaxoSmithKline's quarterly conference call, let's get to the most important question of all: should you be buying GlaxoSmithKline stock?
The answer to this question is really going to depend on your investment timeframe. If you're looking at a minimum five-to-10-year horizon, then buying into the GlaxoSmithKline turnaround could make sense. The company's diversity among its vaccine line coupled with its cost-cuts and expected respiratory growth post-Advair/Seretide give it ample opportunities to reward shareholders. It also doesn't hurt that Glaxo's dividend yield is superior to that of the broad-based S&P 500.
On the other hand, growth by cost-cutting isn't a long-term solution. At some point we're going to need to see Glaxo's newly launched respiratory products really pick up the pace, otherwise Wall Street and investors may push the stock lower.
Personally, I'm a fan of the wait-and-see approach. The catalysts are pretty clear, but I'm not thrilled with the execution as of yet.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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