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GlaxoSmithKline - Progress across the group

Equity research team | 26 October 2016 | A A A
GlaxoSmithKline - Progress across the group

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Progress across the group

GlaxoSmithKline (GSK) increased third quarter revenues by 8% at constant exchange rates, led by strong performances from Vaccines and new pharmaceuticals products. Core earnings per share rose 12%, or 39% once the impact of lower sterling is taken into account.

GSK shares are down 0.7% following the announcement.

Our View

GSK's varied portfolio has been delivering a good level of broad based growth in recent quarters. In particular the increasing contributions from the Consumer Healthcare and Vaccines divisions (now over 40% of group sales combined), should reduce reliance on blockbuster drugs and strained western healthcare budgets. It's a sensible strategy and helps to support the dividend (the current prospective yield is 4.9%, although that is variable and not guaranteed).

The steady decline in revenues from Advair, the blockbuster respiratory drug, has been painful, and there is more pain to come before that process is over. However, GSK's suite of new drugs is growing rapidly to fill the gap. Meanwhile, the group's integration and restructuring drive seems to be on track. That is helping to boost margins across the business and ultimately helping to convert increased sales into increased profits.

For the first time in a long time GSK looks to be facing more tailwinds than headwinds, with the group targeting earnings growth of mid-to-high single digits out to 2020.

At current rates the group should enjoy a whopping 21% currency boost to earnings per share for the full year. However, there's a dark side to that currency movement too. GSK borrow in dollars as well as sterling, and the value of that debt has increased by £1.4bn as a result of a weaker pound. That, combined with a dividend that is still isn't covered by free cash, means that net debt has increased 37% from the start of the year to £14.7bn.

That's our concern with GSK. Historically earnings quality has been low. "Exceptional" restructuring and legal costs have been far from exceptional, while profits have not been well backed up by cash flow. That seems to be changing. But, while we like the direction GSK is heading, we would like to see a durable improvement in cash flow before taking a more positive position on the business.

Trading update:

Quarterly sales exceeded analyst expectations across all three divisions, with Pharmaceuticals up 6% to £4.1bn, Vaccines up 20% to 1.6bn and Consumer Healthcare up 5% to £1.9bn.

Performance was driven by a strong new products, which saw sales grow 79% versus the previous year to £1.2bn. Within the Pharmaceuticals division, new products now account for 25% of total sales.

The group has continued to focus on reducing costs. Incremental savings in Q3 were £0.2bn, bringing total annual cost savings to £2.5bn since the beginning of the initiative, on track for the £3bn target. That has helped boost core operating margin to 30.7% this quarter (Q315: 28%), and supported net cash inflows from operations of £1.8bn in Q3 (Q315:£0.5bn).

The group continues to expect core EPS growth of 11-12% for the full year at constant exchange rates, although current exchange rates are expected to have a positive 21% on 2016 Sterling core EPS growth.

Net debt at the period end was £14.7bn (Q315: £10.6bn). The full year dividend is still expected to be 80p, with a Q3 dividend of 19p.

GSK completed three of the four regulatory filings targeted for the second half of 2016, and expect to start four Phase III trials for assets in HIV, respiratory and anaemia before the end of the year.

Commenting on the Group's new drug pipeline CEO, Sir Andrew Witty, said;

"Our most recent review of the Group's pipeline reinforces our confidence in the near-term portfolio and the options we have in early-to-mid stage development... In the remainder of this year and over the course of 2017/18, we expect to see important data for between 20-30 assets in clinical development and in core therapy areas including oncology and immuno-inflammation."

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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