Since the EU referendum, the UK stock index has been something of a two-tier market. Companies that are UK-focused have seen their share prices come under pressure due to fears surrounding the economic performance of the UK in a post-Brexit world. However, international companies such as GlaxoSmithKline (LSE: GSK) that rely on the UK for a small part of their sales have seen their share prices soar.
In fact, GlaxoSmithKline’s share price has risen by 15% since the EU referendum. This has pushed the company to a two-year high and has reduced its yield to around 5%. Clearly, that’s still a fantastic yield and easily beats the wider index (the FTSE 100’s yield is now less than 4%) as well as many other asset classes such as bonds and property.
However, the 5% yield may not last over the medium term, since investor demand for Glaxo shares could cause its price to rise and its yield to compress. One reason for increased demand is likely to be a positive currency translation, with the firm likely to benefit from weaker sterling since it operates mostly outside of the UK.
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This will not only boost the company’s sales and profitability, but will also make it more appealing to potential bidders. With sales growth in a number of major pharmaceutical companies being somewhat weak, M&A activity could appeal with interest rates being low and Glaxo’s long-term earnings growth prospects being very upbeat.
Treatment pipeline
A key reason for this is the treatment pipeline. It has around 40 possible new treatments in a wide range of applications so the pipeline is large and well-diversified, which should provide confidence to the company’s investors and help to attract new buyers of its shares.
Meanwhile, Glaxo remains a well-diversified business, with a lucrative consumer goods arm. This should provide greater resilience to the patent cycle than is the case for a number of its pharmaceutical peers. And with uncertainty being high across the global economy, investors may become increasingly risk-off and seek out perceived safer stocks, of which the pharma giant is a fine example.
Of course, Glaxo has no plans to raise dividends over the next couple of years, so investors shouldn’t think that their 5% yield will improve over the medium term. However, reinvesting profits for growth seems to be a better and more efficient use of the firm’s capital and in the long run is likely to generate greater profits than if it were paid out as a dividend.
With GlaxoSmithKline trading on a price-to-earnings (P/E) ratio of 18.2, many investors may feel that it’s rather expensive compared to its recent past. While this may be true, it’s due to record significantly better earnings growth numbers over the next two years than it has done in the last four years and so it could be argued that it’s worthy of a relatively high rating.
In fact, an even higher rating is very possible as investors seek out defensive, higher yielding companies with bright long-term growth prospects.
