It’s been a dramatic year for FTSE 100 pharmaceutical group GSK (LSE: GSK). Over the summer, GSK completed the long-awaited separation of its consumer healthcare business.
Investors (including me) were bullish about the new GSK. I reckoned the group’s tightened focus and reduced debt levels would lead to faster growth rates. Unfortunately, I didn’t reckon on the latest big money legal drama to hit the industry — heartburn medicine Zantac.
Legal claims in the US are suggesting that Zantac may cause cancer. GSK disputes the claims, but the market is worried. GSK shares are worth £9bn less than they were before the claims emerged in August.
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For long-term investors like me, there’s a choice to be made here.
Do I take advantage of GSK’s reduced share price and hope to lock in an attractive long-term return? Or should I steer clear of this legal drama until some clarity emerges?
Let’s start with the good news
GSK’s sales rose by 9% to £7.8bn during the three months to September. Adjusted profits climbed 4% higher to £2.6bn. This growth was helped by sales of shingles vaccine Shingrix, as well as specialty medicines in areas such as cancer and immunology.
These numbers suggest to me that demand for the company’s proprietary medicines is healthy. CEO Emma Walmsley agrees, and expects to report 15%-17% profit growth for the full year.
Walmsley is keen to point out that healthcare should be a long-term growth opportunity. I agree. That’s why — in theory — I’d like to add GSK to my share portfolio.
I can’t ignore Zantac
As an investor, one thing I’ve noticed over the years is that major legal problems usually cost more and take longer to resolve than expected.
Looking back over the last decade or so, the PPI mis-selling scandal (banks) and the Gulf of Mexico oil spill (BP) are both examples of this.
I think it’s too soon to know if Zantac will join this list. But the numbers involved look worrying to me.
GSK has already been named as co-defendant in 4,100 personal injury cases representing 77,000 people. The company says it’s also aware of a further 33,000 claims that haven’t yet been filed.
GSK shares: cheap enough to buy?
Even in a worst-case scenario, I don’t think the Zantac claims will threaten GSK’s survival.
Based on this view, it might make sense for me to add the shares to my portfolio at the reduced price we’ve seen since mid-August.
As I write, GSK shares are trading on a forecast P/E ratio of 11, with a 4% dividend yield. That’s significantly cheaper than rival AstraZeneca, which boasts a P/E of 18 and a 2.4% yield.
I can see two reasons for GSK’s discounted valuation. The first is Zantac. The other is that the company’s growth will disappoint investors, as it has done before.
I’d be happy to accept the risk on growth, but I’m not comfortable with the legal situation.
Right now, GSK isn’t even sure how much liability it has. Because Zantac has had several owners over the years, some of these companies are now suing each other to try and limit their liability.
I’m going to stay away from GSK shares until the picture becomes clearer.
