Large cap pharma is somewhat of a minefield for investors at the moment. Patent expiries are exposing sector leaders to competition from generics, drug development pipelines running thin and and require extensive investment or M&A, while many firms are also locked into expensive dividend commitments.
GlaxoSmithKline (LSE: GSK) fits the above bill perfectly, as it is pressured on all fronts with patent expiries, generic competition and price pressures each encroaching upon earnings.
And all this is while the number of new approvals it has pending sits at just two, and management remains locked into a progressive dividend policy that could become a liability if the group’s performance deteriorates by any notable measure in the coming quarters.
To be clear, GSK will need to put this year’s projected contraction behind it and get back to earnings growth if it is to cover its dividend commitments 1x over when 2016/17 comes around.
The devil’s in the details
The competition facing GSK’s Advair — a treatment for asthma and chronic obstructive pulmonary disease — is already hotting up and could get worse still in 2016 when generics begin to make their way into developed markets and Glaxo’s remaining Advair patent ( the Diskus inhaler) expires.
Advair has accounted for 20% of group sales and the income from this product has already fallen by 22% in the US (Q1 2015), as health care bill payers have begun to favour cheaper alternatives.
The US is a market that is yet to feel the impact of generics and if the current situation in India with Cipla provides any indication of what we can expect the US business to look like when they do appear, then the future could be bleak for both Advair and GSK.
Why hold?
On a more positive note, GSK’s HIV products performed well, with sales of new drugs Tivicay and Triumeq reaching £294m, which is significantly ahead of estimates.
These types of results make it unlikely that management will make another attempt to dispose of ViiV Healthcare in the near term, which is important, given that projections for combined sales of roughly £2.5 billion by 2017 mean that the group is in with a chance at offsetting the impact of Advair’s decline.
In addition, the R&D day that GSK is holding for investors in November could see management unveil some improvements in the development pipeline, which would be welcomed by investors and will probably help boost sentiment toward the shares.
Furthermore, management has been frustratingly slow in its progress toward a leaner cost structure which, while disappointing to date, implies that there is still scope for belated progress to boost the bottom line here.
Deep value or dud?
The answer to this question probably depends a great deal upon what management have to say at the up and coming investor day in November.
If the group is able to unveil meaningful progress in advanced clinical trials across key areas such as HIV, Cardio, Respiratory or Oncology, preferably to an extent where it is almost ready to file for approvals, then management will probably be vindicated and the value case for the shares strengthened.
However, if Glaxo cannot bring anything meaningful to the table in November, then it is probable that investors will remain uninspired, that the shares could continue to perform poorly, and that attention within the analyst community could soon begin to focus upon the viability of the dividend from 2016/17 onwards.
If I had to make a call, I’d say that, it probably won’t hurt to hang onto the shares if already invested, at least for the foreseeable future — even if only for the current yield. For prospective new buyers, Glaxo may make a good long term play for those who are blessed with plenty of patience and the required time horizon.
