Over the past month alone the share price of GlaxoSmithKline (LSE: GSK) has leapt over 7% in value but I think there could be further gains ahead for the pharmaceuticals giant. There are a few reasons for my optimism, with the main drivers being a clarification of the intended strategy of the company’s new CEO, the potential for improvements to the balance sheet and continued growth of its core business.
A streamlined strategy
The primary reason its shares have performed so well over the past month is down to investors growing more confident in the direction new CEO Emma Walmsley is taking the company. Although her background is in the consumer health side of the group, which sells items such as toothpaste and flu treatments, she has made it clear that her primary focus is the group’s core pharma expertise, which offers higher growth prospects and higher margins than the consumer side of the business.
She won investors over recently by declining to bid on the consumer health business of Pfizer that was rumoured to be in the works for a sum of some $20bn. Instead, Walmsley passed and instead agreed with Novartis to purchase the 36.5% stake in their consumer health joint venture it doesn’t already own for a more reasonable $13bn. This deal makes a great deal of sense as the joint venture has been performing well and GSK has already done the heavy lifting of integrating the business into its own.
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Furthermore, since Novartis has held an option to sell the business to GSK when it desired any time before 2035, this sale agreement and not bidding on the Pfizer disposal makes the state of GSK’s balance sheet easier to understand for investors. While net debt at year-end of £13.1bn was already elevated against free cash flow of £3.4bn, GSK should be able to safely fund the acquisition and maintain its dividend cover thanks to rising cash flow and a stable earnings outlook. This is especially true if it pursues non-core asset disposals such as that of malted milk drink Horlicks, which could fetch as much as £2.5bn.
Enviable future growth prospects
On top of these reassurances, GSK’s core business continues to perform very well. Last year revenue increased 8% to £30.2bn while adjusted operating profits bumped up 12% to £8.5bn. This performance was driven by solid trading from the consumer health division, sales of new pharma products rising over 50%, and a lack of a generic competitor to blockbuster asthma treatment Advair in the US.
Together, I think these assets put GSK in a great position to grow and see its share price rise significantly in the medium term. The soon to be completely controlled consumer health business should continue to generate steady, non-cyclical growth and high cash flow. This rising cash flow can then be deployed to cover the 5.6%-yielding dividend that looks increasingly safe, as well as investment back into its very full drugs pipeline that is already producing high-growth products. And with its growth prospects and impressive dividend, I reckon at its current valuation of under 14 times forward earnings, GSK could be a bargain for long-term, buy-and-hold investors.
