Friday, 10 December 2010

GSK: Hero or Headache?

The trouble I have with GlaxoSmithKline (GSK), other than the unfeasibly long and contrived name, and that is even after dropping the Beecham part, is that it has done nothing for me. 

I first acquired shares back in August 2006, have topped up from time-to-time, and am sitting on a spectacular gain of...wait for it...8%. That's total, not per annum. Potentially worse still, is that all of that gain (and more besides) is a consequence of dividends. What I want to establish is whether I massively overpaid for the share or whether I've backed a cart horse.

The other reason that it has appeared on my radar, is that a lot of commentators have tipped GSK as a worthy, if dull, defensive play, on a yield of c5% and a PER of c10-11x, giving it the notional characteristics of a value share.

For the record, my average cost per share is £13.18 and I've had £1.82 per share in dividends, which brings my break-even price to £11.36 per share. The current share price is £12.42 (as at 10 December 2010).


GSK is a very large and well analysed company, being the sixth largest company (by value) in FTSE 100. It is likely that, whether you realise it or not, GSK touches some part of your life and your share portfolio.

As the long-winded name suggests, the Company is an amalgamation of companies that have been added/merged en route to support whatever strategy was in place at the time.

Revenues are broadly split between Pharmaceutical products (prescription drugs and vaccines) (84% of 2009 revenues) and Consumer healthcare (medicines, healthcare and soft drinks) (16% of revenues).

The current strategy is three-fold: (1) grow a diversified global business (cue emerging markets growth), (2) deliver more products of value (make R&D pay) and (3) simplify the operating model (improve efficiencies).

The threats that the business faces include: 'genericisation' (drugs coming out of patent - this represented lost sales of £1 billion in 2009); the need for R&D - generally around 14% of turnover - to find new drugs as quickly as they fall off the patent cycle, and an ever-growing litigious society. 

I am not going to pretend that my analysis is going to add anything new to the volumes of research out there, or that I'm going to be able to find a hidden gem in GSK, but I will be taking a big picture view on current valuation versus a historical perspective in particular.  

Source: London Stock Exchange
  In the last 12 months, the shares have traded at a high of £13.39 and a low of £10.95.

However, on a 5 year trend, the highest point was £15.74 in March 2006. This shows neatly why, in hindsight, I bought at the wrong time!

The Rules

1 - Assets - net assets of £10.7bn (December 2009) compares to a market cap of c£64bn. The assets are trading at a significant premium to book-value. There is an element of goodwill from acquisitions, but the 'market value' of the product portfolio is reflected in the market cap  and not on the balance sheet. I am in no position to estimate the future sales of each product on a DCF basis, so I won't attempt to.

2 - Market Cap - with a market value of £64.5 billion, it just about squeezes past my minimum hurdle of £ a factor of 1,290x.

3 - Cash flow - (a) balance sheet - there are net current assets of £5bn, which is encouraging...(b) operating cash - operating cash of £9.5bn less interest of £1bn (top-end) and £1bn replacement capital (guess) = £7.5bn. Out of this, we need to pay the Tax Man £2bn and dividends of £3bn, which leaves a buffer of £2.5bn for future debt payments and strategic stuff (acquisitions etc). On the whole, the cash side of things looks positive.

4 - Debt - (a) a debt to equity ratio of 0.9 is high (for my rules) but probably reasonable for such a large company with stable cash flows; (b) net debt of £9.4 billion, equates to an EV/EBITDA multiple of 8.5x based on an EV of £74bn and adjusted EBITDA of £8.7bn. This represents quite a full multiple and probably reflects the size and relative stability of the cash flows. 

5 - PER -  based upon a 2009 basic EPS of 109p and a current price of £12.42, the current PER is 11.4x, which is beneath the target ceiling of 12x.

If we look at long-term earnings and a 10 year basic EPS of 80.3p, the PER rises to a not-so-much-value 15.5x.

6 - Yield - the 2009 DPS was 61p, representing a yield of 4.9%, based on the current share price of £12.42.  The cover based on 2009 basic EPS is 1.8 times, which is satisfactory.

The Company has a progressive dividend policy in place and increased its 2009 dividend by 7%. In fact, the dividend has increased every year since 2000 (my starting point), and this equates to annualised increase of 5.4%, which represents real growth in income. Good stuff.

7 - ROE - the 2009 ROE (per Sharelockholmes) was 61.4% and the average 10 year ROE is 62.2%. This appears to be high as the denominator (shareholders funds) never seems to increase much as each year's profit is 'spent' on dividends and share buy-backs.

8 - Directors - as one would expect for a large multi-national (nowadays at least), the directors were rewarded handsomely. The director remuneration bill totalled £11.8m (including leavers), and of this, the three executive directors had an average salary of over £2m each.

In addition, the three executive directors directly hold over 200,000 shares (£2.5m), as well as having various share options over c3m shares (at low exercise prices).

9/10 - Buy or Bye? A 10 year average EPS of 80.7p and a 10 year average PER of 15.6x, gives a 'long-term' fair price of £12.59. Interestingly, this is within a whisker of the current market price (£12.42).


I think that GSK is a well-run company with lots of defensive qualities, nice yield, growing earnings and an acceptable capital structure. For me, the current price is a fair price and reflects the fair value of the business. On this basis, the return that I am likely to get from investing in GSK is below my target IRR of 15%, which means that I will probably sell the shares to release the funds for something that does meet my requirements.

Despite being a big admirer of the Company, I can't see sufficient value at this price and, after all, I'm trying to achieve market-beating returns. 

"Price is what you pay. Value is what you get." Warren Buffett

No comments:

Post a Comment