Twenty years ago, GlaxoSmithKline (LSE: GSK) shares traded at more than 2,000p. But over the last two decades, the GSK share price has remained firmly below the £20 level.
Profit growth has been inconsistent, and the firm is still midway through a challenging turnaround. Despite these headwinds, I’m more optimistic about Glaxo than I have been for some years. In fact, I’ve been buying the shares recently. I think they’re cheap. Here’s why.
Look beyond 2020
You might expect a pharmaceutical company to have done well during this year’s pandemic. The opposite is true. Vaccine sales fell by 5% during the first half of the year and pharmaceutical sales were flat. The only bright spot was consumer healthcare, where sales rose by 35%.
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One reason for this is that the coronavirus pandemic has stopped many people going to the doctor’s for more routine visits – such as vaccinations. A second problem is that GSK is still suffering a little from the patent cliff. The group’s popular Seretide and Advair respiratory products have lost patent protection and are now losing sales to cheaper generic rivals.
CEO Emma Walmsley has increased R&D spending to help rebuild the group’s pipeline of new products. The company says that 75% of its pipeline assets are focused on immunology – vaccines. If some of these are successful, this could be good for Glaxo’s profits. The group’s vaccine division is its most profitable business, with an operating margin of 41%.
Consumer business looks cheap to me
There’s a second reason why I’m bullish on GSK shares.
Walmsley is planning to spin out Glaxo’s consumer healthcare business into a new company in the next couple of years. This division owns brands such as Nicorette, Panadol, and Sensodyne, and generated an operating profit of £2,340m over the 12 months to 30 June.
The consumer healthcare business has a portfolio that’s smaller but comparable to FTSE 100 group Reckitt Benckiser. Profit margins are similar too, at around 23%.
Reckitt shares currently trade on 22 times 2021 forecast earnings, despite forecasts for minimal growth. This valuation suggests to me that Glaxo’s consumer healthcare division could also attract a premium valuation as a standalone business.
In my view, this part of Glaxo’s business is probably undervalued, held back by the weaker performance of the group’s pharmaceutical business.
I think GSK shares are too cheap
FTSE 100 rival AstraZeneca has returned to growth after facing similar difficulties to Glaxo. AZN shares now trade on 21 times 2021 forecast earnings.
Although GSK has higher profit margins, the market has punished the group for its lack of growth. GSK’s share price has fallen by nearly 25% so far this year. That leaves the stock trading on just 12 times forecast earnings, with a dividend yield of 5.8%.
I think this is too cheap. I expect Glaxo’s pharmaceutical business to return to growth over the next few years, as renewed investment pays off.
Alongside this, I believe the consumer healthcare business will be more highly valued as a standalone unit. Glaxo shareholders will receive shares in the new company, so should benefit from any revaluation.
I see the current situation as a good opportunity to lock in an attractive dividend income and future capital gains. I plan to buy more GSK shares over the coming months.
