Trials are bread and butter for GSK, but proving to the market that it deserves a higher price is shaping up to be a harder test. A costly legal battle over claims that Zantac, the company’s old heartburn drug, caused cancer has set back the rehabilitation of the shares. More fundamentally? Historic under-investment in research and development has stoked market concerns that the FTSE 100 Big Pharma player will be exposed to a steep fall in revenues as patents expire.
Disproving the latter should start to become easier. GSK has come strong out of the gates this year, which bodes well for cash generation and its ability to support firepower for R&D and deals.
Strip out Covid-related treatments and organic sales were up 10 per cent annually in the first quarter, ahead of market expectations. That is also twice the level targeted under a five-year plan to revitalise the top line and puts it easily on track to hit full-year guidance of between 6 per cent and 8 per cent organic growth.
The plan is to shift into higher-margin specialty medicines and vaccines, which are expected to grow to about three quarters of company sales by 2026 and accounted for 60 per cent in the first quarter. The company reckons it can increase adjusted operating profit ahead of the rate of sales, at between 12 per cent and 14 per cent this year and at a compound annual rate of more than 10 per cent out to 2026.
That means directing cash freed by the demerger of its consumer health division, now Haleon, into plugging the R&D gap in four core therapeutic areas: infectious diseases, HIV, oncology and immunology and respiratory. In each of the five years before Dame Emma Walmsley’s appointment as chief executive, R&D spending either contracted or lagged revenue growth. Since then, spending has kept pace with revenue growth.
If GSK can hit five-year performance targets and can prove it is rebuilding the drugs pipeline, then it might start to close the weighty discount attached to the shares compared with AstraZeneca, its London-listed rival, as well as with international peers such as Pfizer and Merck. An enterprise value of just over seven times forecast earnings before interest, taxes and other charges is around that of Astra.
How much ammo does GSK have? Enough. A £7.1 billion dividend received from spinning off Haleon was a big shot in the arm and it also retains a 13 per cent stake in that business, which will be reduced at some point. Even if half the proceeds have been earmarked for its pension funds, that would leave £2 billion in cash left. The business itself churned out £3.3 billion in free cash from its operations last year. It is also comfortable enough with net debt, which stood at around twice adjusted profits at the end of last year, down from 2.5 times in 2021.
Putting those funds to work should help to ease investors’ concerns over the patent expiry of dolutegravir, its blockbuster HIV treatment, from 2027, which accounted for £1.3 billion, or almost a fifth of sales in the first quarter. The group has 17 drugs in late stage trials or the registration phase. Those include its vaccine for RSV, for which it expects to receive regulatory approval in the crucial American market next month. That treatment could have Shingrix-like performance, GSK reckons, referring to its shingles treatment that last year brought home £3 billion in sales.
Zantac remains the biggest risk. The company’s defence achieved a win in December when about 50,000 cases were dismissed in a pre-trial federal court hearing in Florida. Cash has been set aside for legal fees, but no provision has been made for any potential settlement.
The balance of risk here is already reflected in a depleted share price. GSK should start to be given more credit.
ADVICE Buy
WHY The shares look undervalued given progress on sales growth and the strength of the balance sheet
Reckitt
Putting an inside man in the top job tells Reckitt shareholders to expect little strategic change. The problem? Faith in said strategy is lacking.
Like its peers in the highly mature and competitive consumer goods market, Reckitt has struggled to deliver consistent revenue growth. True, organic sales guidance for this year has been raised to between 3 per cent and 5 per cent, including the impact of lapping a baby formula supply slump in the United States that boosted sales last year. Consensus had been looking for only a 3.1 per cent increase. Like-for-like sales growth has not dipped below 3 per cent over the past 12 quarters.
Yet the impact of the pandemic on sales of health and hygiene products, such as Harpic and Dettol, has hugely skewed sales, as has double-digit inflation. Like-for-like growth over the first three months of the year was 7.9 per cent, but that was the product of 12.4 per cent in aggregate price rises, while volumes were 4.5 per cent lower. The latter is set to decline somewhere in the low-single-digits this year, at least the same, or perhaps worse, than the 2.2 per cent fall in volumes last year.
The question is whether Kris Licht, the new Reckitt boss, will have to overhaul the portfolio further to reinvigorate the top line. The appointment of an internal candidate as chief executive indicates no big heavy lifting. And targets for disposal are less obvious, which makes acquisitions in higher-growth parts of the health and hygiene markets a more likely method of lifting sales growth. Vitamins, supplements and more advanced pain medication have been pointed to by analysts as potential sources of deals.
Will Licht follow Laxman Narasimhan, his predecessor, and reset margin expectations? The group has stuck with a target of an operating margin in the mid-twenties by the mid-2020s, which would put it near the top of the peer group. But spending on promotion is likely to need to increase. Last year, that stood at 11.8 per cent of revenue, against 18.7 per cent at Haleon, a peer with a similar-sized gross margin.
ADVICE Hold
WHY A clearer record on organic growth is needed
