Neil Woodford’s recent decision to dump pharma giant GlaxoSmithKline (LSE: GSK) after 15 years surprised many. But after reading Mr Woodford’s Glaxit blog post, I got the feeling he’d have sold the stock sooner if he’d been able to find a suitable replacement for the income it provides.
Glaxo shares have edged lower today following the publication of the group’s half-year results. Like Mr Woodford, I sold my shares earlier this year. Based on today’s showing, I’m pleased I did.
Changes are coming
Today’s results give us our first real view of new boss Emma Walmsley’s plans for the firm. Aside from the planned sale of Horlicks, which has already been announced, we now know that Glaxo plans to stop “more than 30” pharmaceutical development programmes. The company’s Rare Diseases unit may also be sold.
The remaining pharmaceutical pipeline will be reviewed in order to allocate 80% of capital to priority assets. Meanwhile a cost reduction programme will be extended to deliver an additional £1bn of annual cost savings by 2020.
Last but not least, there will be an “enhanced focus” on cash generation and improving the group’s credit profile. Dividend growth will be put on hold until the payout is covered at least 1.25 times by free cash flow.
Get ready for a cut
Taken together, these changes suggest to me that Mr Woodford’s criticisms of Glaxo were accurate. The group’s breadth and its diversity seem to have resulted in a large number of underperforming projects.
This wasteful use of cash might have been spotted sooner if the business had been split into several more focused companies, as Woodford and others have advocated.
In the meantime, cash generation has deteriorated. Net debt rose from £13.8bn to £14.8bn during the first half of the year. Dividends were to blame. Glaxo returned £2,049m to shareholders during the period, but only generated about £1bn from free cash flow, asset sales and exchange rate gains.
Although today’s guidance indicates the dividend will be maintained at 80p in 2017 and 2018, this is subject to there being no major change in “performance expectations”. This is far from certain. I think there’s a real chance the dividend will be cut in 2018 or 2019.
Sales are still rising
Group turnover rose by 3% to £7,320m during the first half, excluding the impact of exchange rates. On the same basis, US sales rose by 5% while European sales eked out a 2% gain.
Profits improved too, although most of this was down to exchange rates. Glaxo’s adjusted operating profit for the six months to 30 June was £4,062m. That’s 21% higher than last year at actual exchange rates, but only 4% higher if exchange rate gains are ignored.
I’m staying away
The big news today wasn’t about the last six months’ trading. It was about the future. My strong feeling is that the changes announced today put the company at the start of a period of renewal.
This is unlikely to be a quick or easy process for a company of this size and complexity. My view is that there will probably be better buying opportunities over the next year or two. So I won’t be adding GlaxoSmithKline back into my portfolio just yet.
