Questor share tip: Buy GlaxoSmithKline for the long term

GlaxoSmithKline shares are unloved and cheap following bribery allegations, but the cash and dividend make them a buy, says Questor.

GlaxoSmithKline
£15.43-9p
Questor says BUY

PHARMACEUTICAL giant GlaxoSmithKline has been in the headlines for all the wrong reasons this year, but despite the bribery allegations and drug trial failures, Questor believes the shares remain a solid investment for the long term.

That, after all, is the basis of value investing: being able to look through the short-term noise and focus on the fundamentals. In fact, the first rule of value investing as outlined by Benjamin Graham, a guru of the practice, was “to ignore the glamour stocks of the day and look for companies that were out of favour, misunderstood or apparently priced too cheaply”.

Glaxo certainly qualifies on the first two points. It is firmly out of favour following bribery allegations in China, Iraq and now Poland that have resulted in the shares consistently underperforming the wider FTSE 100 during the past six months. What’s more, pharmaceutical shares, including Glaxo’s, have been going sideways for the past 12 years, as the companies grapple with the loss of profitability as patents expire on their products.

Pharma companies generate income from new drug discoveries. Glaxo’s problem is that its stable of drugs is getting old. Patents run out on drugs that are old, and then cheap copies, or generics, can be made, which damages sales and lowers the price, the so-called “patent cliff”.

So why should investors buy shares in a company mired in scandal that is slowly having its profitability eroded? Well, nothing lasts for ever, and that includes bad news.

The starting point is that Glaxo will certainly outlast its problems. The world’s fourth-largest pharmaceutical company after Pfizer, Novartis and Sanofi has been around in one form or another since 1843 when Sir Thomas Beecham started up in St Helens. The company in its present form came into being when Glaxo Wellcome merged with SmithKline Beecham in 2000.

The pharmaceutical industry has high barriers to entry, and the revenue is supported by ageing populations in the Western world.

Glaxo has an exciting drug development pipeline that will provide new revenue if successful. The company has 13 drugs in the final stage of testing, the results of which are expected during the coming 12 months. There was disappointment when the company stopped a late-stage trial of its cancer vaccine MAGE-A3 after disappointing results. However, the rest of the pipeline is intact.

The company is forecast to generate more than £5bn in free cash flow this year, which more than covers the £4.1bn in prospective dividend payments that offer a yield of 5.2pc.

There are clearly risks from this latest reputational setback in Poland. Glaxo has stopped all payments to doctors for speaking arrangements and attending medical conferences.

Glaxo has said that an internal investigation found “evidence of inappropriate communication in contravention of Glaxo policy” by a single employee. The company has taken disciplinary action, but what concerns Questor is whether regulators in the US decide rules have been broken, and this would prove far more costly.

The shares are now trading on 14 times forecast earnings, falling to 13 times next year. That represents a discount of about 15pc when compared with peers in the European pharma sector. The shares also offer a forecast dividend of 5.3pc, which is expected to increase by 5pc a year during the next two years. There is no escaping that the shares have been a disappointment since Questor recommended buying last year (£16.73, August 24), down 8pc when compared with the FTSE 100, which has inched up 0.8pc. However, Questor is comfortable holding the shares for the long term. Buy.