GSK’s (LSE: GSK) share price is 9% down from its 15 May 12-month traded high of £18.19.
This compounds the stock’s already extreme undervaluation against its competitors apparent to me beforehand.
Specifically, on the key price-to-earnings ratio (P/E) measurement of relative stock valuation, it trades at just 16.7.
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This is at the bottom of the list of its peers, with an average P/E of 36.1. the group comprises Merck KGaA at 29, Zoetis at 35.5, CSL at 37.8, and AstraZeneca at 42.
The same extreme relative undervaluation for GSK also applies to the price-to-book (P/B) and price-to-sales (P/S) ratios.
GSK trades at a P/B of 4.7 compared to its competitor average of 8. And it trades at a P/S of 2.1 against a peer average of 6.3.
I used a discounted cash flow analysis to translate these ratios into hard cash terms for a fair value for GSK shares.
This shows the stock to be 71% undervalued at its current price of £16.50. Therefore, a fair value for the shares would be £56.90, although they might trade lower or higher than that.
Fundamental factors look good
On several key measures of the fundamental soundness of a business, GSK looks in great shape to me.
Over the first half of this year, sales rose 12%, to £15.247bn. Core operating profit jumped 22%, to £4.956bn, and core operating margin increased by 2.9%. Cash generated from operations went up by 46%, to £2.776bn.
Additionally, its net debt-to-EBITDA ratio of only 1.3 is well under the 1.5 level considered healthy. And its EBIT covers its interest expenses by around 16 times.
Moreover, consensus analysts’ expectations are that GSK’s earnings will grow by 14.4% a year to the end of 2026.
Ultimately, rises in earnings power a company’s share price (and dividends) higher over time.
As an adjunct to this, analysts predict that GSK’s dividend yield will rise from the current 3.5% to 4.1% by end-2026.
So what’s the problem?
The overriding reason – and main ongoing risk — keeping the stock price down is litigation over GSK’s Zantac (generic Ranitidine) drug.
A best-selling heartburn medication after its US approval in 1983, Zantac was first linked to cancer in 2019.
GSK had previously settled various lawsuits. However, on 31 May a US court in Delaware ruled that 70,000+ new lawsuits could go to trial. This raises the spectre of high compensation being awarded against the firm if the litigation succeeds.
Positively for GSK, a jury in Chicago ruled on 5 August that the drug was not responsible for an Illinois woman’s cancer.
Also positive is Delaware’s Supreme Court upholding on 27 August GSK’s appeal for a review of the expert testimony given in the case.
If the review favours GSK, it could end some or all the 70,000+ cases against the firm. GSK maintains there is no consistent or reliable evidence that Ranitidine increases the risk of any cancer.
Will I buy more?
I built my holding in GSK over many years at various prices, so am happy with that position.
If I did not have it, I would certainly use this dip to buy the stock, given its extreme undervaluation and excellent growth prospects.
