Glaxo is cheap given growth and income

GlaxoSmithKline's first-quarter results, published midweek, missed consensus forecasts by about 2% as sales were a little light and costs a touch higher than expected. However, the drug titan made the generous dividend safe from cuts for the next three years and predicted double-digit earnings growth next year.

As part of a recently-completed three-part deal with Novartis, Glaxo has paid £3.3 billion for the Swiss firm’s global vaccines business, set up a consumer healthcare joint venture, and sold its oncology business to the Swiss for £10 billion. Net after tax proceeds are about £5 billion.

Of that, Glaxo had planned to return £4 billion to shareholders. But following a review of its cash allocation strategy, the company has instead decided to hand back around £1 billion, or 20p per share via a special dividend alongside the regular fourth-quarter payout.

That does mean that bosses have the confidence to confirm an annual ordinary dividend of 80p for each of the next three years, soothing fears that weaker earnings might force a cut.

After a sharp drop in earnings in 2015 - due mainly to ongoing pricing pressure on Advair in US/Europe, the dilutive effect of the transaction and the inherited Novartis cost base - management now expects double-digit growth in 2016 as deal benefits feed through.

"The new balance of the croup provides a better basis for generating long-term sustainable growth. GSK expects annual group revenues to grow at a CAGR [compound annual growth rate] of low-to-mid single digits on a CER [constant exchange rate] basis over the five year period 2016-2020," said Glaxo.

"GSK expects earnings to grow faster than sales with group core EPS expected to grow at a CAGR of mid-to-high single digits on a CER basis over the five year period 2016-2020."

UBS remains positive, too.

Cancelling the £4 billion B-Share scheme reduces core EPS by 2.4%, or 2p, says the broker, and core 2016-2020 profits by 4.9%, or 4.5-5p. Medium-term guidance implies 2020 core EPS of 118p.

"Guidance should require consensus upgrades - mid-point guidance for 2017e implies 95p (range 89-101p) vs latest consensus of 94.9p, or 90.3p if buyback is removed," adds UBS. Company guidance for low-to-mid single digit revenue growth for 2016-2020 is in line with the broker's own forecasts, as are estimates for consumer, vaccines and pharma.

UBS also backs Glaxo's plan to abandon an IPO of its stake in HIV drugs business ViiV Healthcare. "We believe this is very good news, as in view of strong growth from ViiV, an IPO would have been dilutive," it says.

After an indiscriminate stockmarket sell-off on Thursday, Glaxo shares currently trade at 1,461p, a three-month low and down 11% since early April. Based on UBS earnings forecasts for 2016 of 93.1p a share, that gives a forward price/earnings (P/E) ratio of 15.7.

Not enough, says UBS. The broker bases its target price on 18 times earnings, implying a price target of 1,700p. There's a prospective dividend yield of 5.5%, too.

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