Summary
- GlaxoSmithKline reported dismal revenues and earnings for the first quarter of fiscal year 2014 due to the price pressures in the USA.
- GlaxoSmithKline will focus all of its strengths on its core businesses after entering into a multi-billion dollar deal with Novartis AG.
- The pharmaceutical giant is bolstering its respiratory portfolio with research on development on major treatments for COPD, a chronic lungs disease.
- The COPD drug market is set to grow at a CAGR of 8% reaching a level of $17.5 billion by 2018.
- Despite some challenges GSK is optimistic of the growth prospects in the Indian drug market and has raised its investment in the market by $1 billion.
Big pharmaceutical companies are aiming at shedding their smaller, less profitable or non-core businesses in order to focus on their principal growth drivers. Also many pharmaceuticals are on an acquisition spree and are acquiring the established segments or product pipelines of other pharmaceuticals to establish their foothold in their respective strong markets. These acquisitions and divestitures will actually start paying off in a couple of years but their immediate effects will be evident in the company’s cash flows. In order to ascertain the potential future prospects of pharmaceuticals these acquisitions and divestitures cannot be ignored. This article will shed some light on GlaxoSmithKline’s (GSK) performance during the recently ended quarter and its future prospects. Investors’ stance regarding the stock will also be considered at the end.
Glaxo-Novartis Multi-billion Dollar Deal
GlaxoSmithKline derives 70% of its top line from four core businesses: respiratory, HIV, vaccines and consumer health. The remaining 30% of the revenues are contributed by the company’s legacy products and its cardiovascular/metabolic business. The company aims to improve its operating margins and thus it has decided to divest its legacy products.
GlaxoSmithKline has entered a multibillion dollar deal with Novartis AG (NVS) according to which GlaxoSmithKline will be selling its oncology segment to Novartis and buying its vaccines business. The inclusion of Novartis’ vaccines business will make GlaxoSmithKline the global leader both in terms of market share and scale in vaccines. About 6000 cases of cancer are diagnosed in the US each year. Despite the fact that the cancer market has substantial long term growth prospects Glaxo divested its oncology segment for $16 billion. This move portrays the seriousness of the company’s management towards focusing on those parts of the business that have global scale and are at the heart of the pharmaceutical giant’s focus. GlaxoSmithKline’s cancer business contributed revenues of $1.6 billion to its top line which seems modest compared to the sale price of $16 billion. Moreover, GSK held the fourteenth position in terms of market share in the oncology sector and it was unlikely for the company to find its way up to the top position because it lacked promising immunotherapies in its pipeline.
Hence by selling its cancer business the company’s management has made a wise decision and not only unlocked substantial value for its shareholders but also freed up resources for the rest of the business. However, GSK will continue some cancer related R&D but Novartis will be the first to claim commercial rights for all future cancer products.
Apart from the oncology divestiture, the announced joint venture in the consumer healthcare segment will also prove fruitful for the company as it will have a 63.5% stake in the venture. According to the company this venture will generate almost $11 billion in revenues annually and with its 63.5% stake GSK will be driving approximately $7 billion annual revenues from the venture. In the first quarter of fiscal year 2014, the consumer healthcare business of GSK experienced 6% sales growth globally except the US and Europe and outpaced all other segments in this regard. As a result of the venture the company’s market positioning will be more robust and it will be able to compete more effectively with consumer heath product giants like Unilever (ULVR) and Colgate Palmolive Co (CL). As part of the deal GlaxoSmithKline has the right to either sell its holding or buyout the share of its partner at the end of three years. Undoubtedly, GSK’s management will make the right decision at that time serving the interests of shareholders in the best possible manner.
These divestitures, acquisitions, and joint ventures will bode well for the company’s future not only for their contribution to the top line but also for the cost benefits they can offer. Combining the Novartis consumer health and vaccines businesses can bring enormous synergies to GSK in the form of lower manufacturing, sales, and administrative costs. GSK has provided an estimate of £800 million ($1.3 billion) in costs-saving every year.
GlaxoSmithKline Diversifying its Respiratory Portfolio
GlaxoSmithKline reported dismal revenues and earnings as the first three months of fiscal year 2014 came to an end. Sales for the first quarter totaled $9.45 billion driving the company’s core earnings down by almost 20%. Analysts at Thomson Reuters expected the core EPS for the quarter to be $0.35 on revenues of $9.85 billion. Revenue for the quarter declined 2% year over year on a constant currency basis. GSK has provided its target and hopes to achieve 4-8% growth in EPS for fiscal year 2014 without providing an explicit figure for the sales growth over the year.
The recent revenue plunge was related to the sluggish performance of GSK’s flagship lung drug Advair and respiratory drug Breo. Breo is GSK’s new respiratory drug and experienced slower than anticipated sales due to the lack of healthcare contracts for the medicine. The US market remained tough for the company due to severe pricing pressures that hindered the company’s revenue growth. However, GSK has been provided with approval by the European Commission to market another respiratory medicine, Incruse. Incruse is a bronchodilator used for patients with chronic obstructive pulmonary disease (COPD) and is expected to be launched in Europe by the end of this year. Apart from this GSK announced by the end of last month it would start the phase III testing for Mepolizumab in patients with COPD. GSK has two more medicines/ treatments in its phase III product pipeline that deal with COPD. Both of these are being manufactured in license or in alliance with third party manufacturers.
COPD is a disease of the lungs that includes chronic bronchitis, emphysema or both and it affects 4-10% of the adult population in Europe. The prevalence of this disease is increasing worldwide and it is projected that COPD will cause more than 6 million deaths annually by 2020. Therefore the COPD drug market is expected to grow at a CAGR of 8% reaching a level of $17.5 billion by 2018. It is a good sign that GSK is no longer dependent on its best seller Advair and is putting efforts into developing a robust portfolio for its global respiratory franchise to meet the specific needs of each individual patient. This will allow the company to enhance its market share in this space and will bolster its top and bottom lines over time.
Exposure to International Markets
GlaxoSmithKline has been battered by bribe allegations and has experienced a less than hospitable environment in China. Therefore the company has increased its exposure in the Indian market by raising its stake in a publicly-listed pharmaceutical subsidiary in India from 50.7% to 75%. The increased ownership of the subsidiary cost the parent company 64 billion Indian rupees (USD$1 billion). GSK’s s Indian subsidiary is called GlaxoSmithKline Pharmaceuticals Ltd (GSK RX India) and is one of the market leaders with a turnover of 2080 Crore (USD$0.35 billion) and a market share of 5.1%. Moreover GSK aims to double its drug production in India by building a second factory there for about $140 million. This underscores the high hopes GSK has attached to the Indian economy and pharmaceutical business. GSK has casted a vote of confidence in the future growth prospects of its business in India by committing a serious amount of investment in the country.
India is a tough market to operate in because of the lack of explicit legal system that can ensure patent protection to pharmaceuticals. Twenty percent of GSK’s global production is sold in India but it only contributes 3% to the company’s top line. This is because of the government imposed price cuts on many basic drugs and the potential threat of compulsory licensing. A wide range of Indian pharmaceuticals are also playing their role in pressuring prices downwards by selling copies of off-patent drugs. GSK, like many other internal pharmaceuticals, is forced to cut its product prices in order to penetrate the market and sometimes it sells its products at just 10% of its international prices. Operating in the Indian market carries uncertainties regarding patent security as well as it demands more collaboration on drug safety making it difficult for international companies to conduct clinical trials in India. Keeping all of these limitations in mind, India, that was expected to become the eighth biggest pharmaceutical market by 2016, is now projected to only reach the 11th position by 2017. Nevertheless, GSK is optimistic about the market growth and expects it to strike the double digits in 2014. This optimism may pertain to the change of government in India as a result of elections where the Bharatiya Janata Party is likely to win. If the actual results of the election go in favor of this party, then the threat of compulsory licenses will diminish. Apart from this, the initial policy announcements made by the new government will either favorably or adversely impact GSK’s operations.
Another key thing to note is that GSK is not the only pharmaceutical investing heavily in India. Other pharmaceuticals like Abbott Laboratories (ABT) and Novartis are also betting on the market. Moreover, Sanofi SA (SASY) and Astrazeneca Plc (AZN) are expected to be the next big pharmaceuticals that are considering stepping up their investments in India. This reassures the fact that despite the tough market environment India seems to be a potentially lucrative growth market for pharmaceuticals.
Final Take
GSK has made a deal with Novartis that will bode well for the company’s future. Despite the pricing pressures the company is facing in various countries it operates in its operational efficiencies can help to deliver sustainable growth. Earlier last year, GSK had announced it would undertake restructuring in Europe that would save $1.6 billion annually by 2016. During the prior three month period GSK stock secured a price appreciation of 8.31% that was in line with that of Merck & Co (MRK) and outperforming Pfizer (PFE). However GSK underperformed AstraZeneca by a greater margin of almost 20%.
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Source: Y-Charts
GSK is facing some challenges in China and other mature markets like the USA and Europe in terms of competition and pricing pressure. However, it has undergone some serious efforts to streamline its core business. Now it aims to focus on areas of its real strength and exiting those where it lacks the scale to compete. Its late stage product pipeline is also robust enough to warrant future growth potential for the company. Its stock has rewarded its investors with an ROE of 84.96 that is 4 times the industry benchmark. The stock is also trading at a P/E multiple of 14.71 that is at 2.2 times discount to the industry P/E multiple. Therefore, I believe this stock deserves a long term investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.
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