Should I buy shares in GlaxoSmithKline?

GlaxoSmithKline has been accused of market abuse by the Office of Fair Trading (OFT).

The consumer watchdog alleged that the pharmaceutical giant paid competitors Alpharma, Generics UK and Norton Healthcare to delay the release of their versions of GSK's Seroxat treatment. Seroxat is used to treat depression.

GSK denied the allegations, stressing that it "acted within the law" and added "the OFT investigation covers matters that have already been investigated by the European Commission in 2005-2006".

Although the news took the shine off GSK shares, the stock made a major breakout to 1,700p earlier this week, a level last seen a decade ago.

Pipeline a catalyst?

The shares are at a 10-year high following Breo's success.

Breo is an experimental treatment for smoking-related lung damage and a treatment for chronic obstructive pulmonary disease (COPD), including conditions such as chronic bronchitis. If approved, Breo would trade as 'Relvar' outside the US.

Breo was endorsed by an initial US Food and Drug Administration (FDA) advisory committee meeting on Thursday by a vote of nine to four. The vote on the drug's safety on Friday was also better than expected, passing by a margin of 10 to three. The final decision rests with FDA and is expected before 12 May.

Breo is an important milestone for GSK, as analysts said it may provide mitigation against pricing pressures in the COPD market.

The market for COPD treatment is vast: in the US alone, COPD was the third-highest cause of death, according to federal data; it is the sixth-most-common cause of death in England and Wales; and is expected to be the third-highest cause of death worldwide by 2030 according to the European COPD Coalition.

Moreover, of the 10 leading causes of death in the United States, COPD is the only one to have increased in frequency over the past three decades, according to James Crapo's Atlas of Chronic Obstructive Pulmonary Disease.

"With one down and 13 pipeline opportunities remaining following [Thursday's] positive endorsement of Breo, the reasons to own the shares remain despite the lofty valuation," stated Savvas Neophytou, analyst at Panmure Gordon.

The coming year promises a number of regulatory decisions which could significantly impact forecasts for GSK, including likely FDA decisions on Advair, two melanoma drugs (end-May/June), HIV drug dolutegravir (August) and the LABA/LAMA combination, Anoro (December). In addition, phase III data is expected on two very high risk/reward products: the cancer immunotherapy drug MAGE-A3 and heart drug darapladib.

But Mike van Dulken, head of research at Accendo Markets, pointed out: "Patent expiry of blockbuster drugs (>$1 billion revenues) is already a big issue for major pharma, with profitability dented in 2012 as a result."

First-quarter results a non-event

The company is due to report its first-quarter results on April 24.

After a disappointing 2012, when GSK failed to meet its starting prediction of a return to sales and margin growth, the company has guided to only slight sales and earnings per share (EPS) growth in 2013 of 1% and 3-4% respectively.

As part of this modest outlook, the company warned at its full-year results that tough comparators on certain brands and business areas would particularly affect its first-quarter performance.

"To the extent that the company has already forewarned about the quarter, we do not see the precise numbers as meaningfully impacting the shares - especially as we believe the main share price driver this year will be pipeline and regulatory news," commented Mark Clark, analyst at Deutsche Bank.

"Beyond the details of the financials, we expect investors to seek commentary with the first-quarter results on the ongoing reviews of the price-impacted European business and of the soft drinks brands, Ribena and Lucozade," he added. Clark estimated these brands could generate between £1.5 billion and £2.5 billion in a disposal scenario.

Neophytou echoed this view: "The company's first-quarter results are not expected to provide a catalyst for further re-rating and investors may decide to take profits at 1,650[p]. Europe remains a problem and it may be too early to see signs of operating leverage yet as the business remains in investment cycle with the pipeline bulging in phase III this year.

"Further upgrading opportunities may arise in the next few weeks but we do not expect first-quarter results to provide that trigger."

At a premium to the sector...

In terms of valuation, the stock is trading on a 2013 price/earnings ratio of about 14 times, a 10% premium to the sector on 12.6 times.

"Although not the cheapest, the company has been through the majority of its patent expiries, big liability settlements and boasts a strong balance sheet and very little [merger and acquisition] risk," noted Neophytou.

...But shareholder returns strong

In addition, GSK stock offers strong shareholder returns: a secure dividend yield of around 5%, with analysts forecasting between £1 billion and £3 billion of share buybacks.

Analyst recommendations

Deutsche Bank rated the stock a 'hold' with a 1,530p price target, stating: "Up/downside risks relate to regulatory decisions and phase III readouts on new drugs and delivery of the predicted return to growth."

UBS also had a 'neutral' recommendation on the stock, but acknowledged: "We continue to be above consensus on GSK longer-term pipeline sales and expect further visibility from mid-2013, highlighting potential catalysts in (1) MAGE-A3 cancer vaccine data in [the second half of 2013]; (2) darapladib (atherosclerosis) data from end-2013; and (3) regulatory decisions across 2013 for respiratory assets Breo/Relvar and Anoro."

Analysts at Morgan Stanley rate the stock 'equal-weight', saying consensus expectations for revenues, margin progression and pipeline create "an unattractive risk-reward profile".

Panmure Gordon was more optimistic with a 'buy' recommendation and 1,850p price target, explaining: "Europe remains sickly, but we should start seeing signs of operating leverage this year, albeit moderated by high levels of investment in research and development as the pipeline reaches maturity."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.