GlaxoSmithKline: Why I Bought Shares Of This High-Yield Health Care Stock

Health care giant GlaxoSmithKline (NYSE:GSK) is a company shrouded in controversy right now. It is reeling from a bribery scandal in China, and was recently fined $500 million for this. Investors have responded by selling the stock. GlaxoSmithKline is down about 15% just since the start of the year. But underneath the scary headlines, it appears that things aren’t so bad. GlaxoSmithKline’s financial penalty is a small amount for a huge pharmaceutical company, and the company recently unveiled an earnings report that was better than analysts expected.

GlaxoSmithKline is now a cheap stock with a compelling valuation that is very attractive. Plus, the stock pays a high dividend yield. Finally, earnings growth should resume once the scandal has passed, making the recent sell-off appear overdone. That is why, for all these reasons, I recently bought shares of GlaxoSmithKline. Here is why I believe the stock can produce strong returns going forward.

GlaxoSmithKline has a robust pipeline

It goes without saying that the biggest concern when investing in a pharmaceutical company is its pipeline of products that will fuel future growth. The overriding fear surrounding GlaxoSmithKline is the company’s fate in a post-Advair world. Since Advair lost patent exclusivity in the United States, the company has seen its sales in the U.S. suffer. To that end, total sales were down 10% last quarter in the United States.

Fortunately, sales growth in other parts of the world is greatly helping to offset this. Sales of pharmaceutical products and vaccines, GlaxoSmithKline’s core businesses, increased 12% in the emerging markets. Sales of pharmaceuticals and vaccines grew 65% in China and 30% in Brazil last quarter. Growth potential remains compelling in under-developed nations, which serves as a future catalyst. This is largely because of GlaxoSmithKline’s solid pipeline. It is working on treatments for a variety of diseases, including HIV, COPD, and severe asthma. GlaxoSmithKline is also in the early stages of developing an Ebola vaccine.

The market potential for these drugs is strong because they are focused on lucrative areas. For example, GlaxoSmithKline projects the market size of HIV drugs to be 12.3 billion euros ($15.3 billion), and the total market for respiratory inhalers to be 13.4 billion euros ($16.75 billion). Fortunately, GlaxoSmithKline has received favorable outcomes for its key drugs in these areas. Last quarter, its Arnuity Ellipta asthma drug was approved in the U.S., as was its HIV product Triumeq, which was approved in the U.S. and the EU.

In fact, the combined global market values for the respiratory, HIV, oncology, and diabetes markets, in which the company recently launched new drugs, is 30.1 billion euros, according to GlaxoSmithKline’s estimates. This equates to roughly $37 billion based on current exchange rates. If GlaxoSmithKline captures just 5% of these sales with its new products, the company could bring in $1.85 billion from these sales, which would add several percentage points to revenue growth going forward.

In addition, GlaxoSmithKline also has a plan to replace Advair, which was previously a very important drug for the company. Its total respiratory segment suffered an 8% revenue decline last quarter, due to falling prices and sales of Advair. But other products in GlaxoSmithKline’s respiratory portfolio, such as Breo, are promising, which is why management expects the company to resume sales growth from respiratory drugs in 2016.

Sales growth across several new markets and products will help produce earnings growth in the future. In addition, earnings will be boosted by GlaxoSmithKline’s significant cost-cutting program. Management recently announced it will shave as much as one billion euros off its cost structure, thanks mostly to its divestment of certain oncology products.

Cheap valuation and high dividend yield are tempting

Because of GlaxoSmithKline’s steep drop in share price this year, the stock’s valuation is now compelling when compared to its peers. This is especially true considering GlaxoSmithKline’s high dividend yield, which is also above-average. Here is how GlaxoSmithKline compares to its closest competitors, Bristol-Myers Squibb (NYSE:BMY) and Johnson & Johnson (NYSE:JNJ).

Clearly, GlaxoSmithKline is attractively valued when compared to its closest competition. The stock’s valuation is down to low levels when stacked up against Bristol-Myers Squibb and Johnson & Johnson, and I believe GlaxoSmithKline is a much better investment candidate because of this. Assuming GlaxoSmithKline returns to modest earnings growth, its valuation multiples should expand to at least a market multiple. An earnings multiple just in-line with the S&P 500 would result in significant capital gains, and that doesn’t even include the hefty 5.7% dividend yield, which is far higher than its two peers.

GlaxoSmithKline’s forward valuation seems too low considering the biggest anchor on the company right now, the bribery charge in China, has been settled and is a one-time occurrence. GlaxoSmithKline should meet its future earnings estimates thanks to its pipeline of products.

For these reasons, double-digit total returns over the next year are absolutely possible. I believe the market has overreacted to the bribery charge in China, and that the company will recover from this in a short time. Once the headline risk passes, investors will likely feel comfortable buying the stock again. Until that happens, I will gladly accept the hefty dividend payments. That’s why I purchased shares of GlaxoSmithKline.