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Shares I love: GlaxoSmithKline

Liontrust's Julian Fosh explains why he thinks the drugs giant is a good investment
August 27, 2014

Julian Fosh, manager of IC Top 100 Fund Liontrust Special Situations (GB00B0N6YF70), believes drugs giant's GlaxoSmithKline (GSK) offers "compelling value".

"Recent short-term disappointments in the form of lacklustre second-quarter numbers and the ongoing Chinese corruption investigation have not, in our opinion, altered GlaxoSmithKline's long-term characteristics or fundamentals, although they have driven the share price to a level at which it offers compelling value," says Mr Fosh. "The shares now offer a prospective return on capital almost twice that of the market average, yet are trading on valuation levels which are well below the market, while its management has explicitly committed to align corporate strategy with enhancement of shareholder value.

"Recent management comments that a break up might be considered are entirely appropriate and such a strategy would most likely reveal substantial hidden value which near-term earnings forecasts do not."

The last IC recommendation on GlaxoSmithKline shares was Buy at 1,503p on 23 July 2014. As at 27 August 2014, the shares were trading at 1,454.6p.

Mr Fosh says that he likes GlaxoSmithKline, as well as the other drugs companies, because:

■ its business model is built on the importance of intellectual property; and

■ large amounts of money are spent on research and development to discover blockbuster drugs which, when patented, allow the companies to earn excess returns throughout the life of the patent. It has been our experience that the market systematically underestimates the cash flows accruing from this source, even when the drugs in question go off patent.

"In the last decade, as blockbuster drug discoveries have become less, so the second intangible strength - global distribution - has come to the fore," he says. "Deals with other companies to distribute its unique products such as that with Dr Reddy's of India have allowed GlaxoSmithKline to leverage the strength of that company's sales force.

"By these means, and by diversifying into consumer products, the company has managed to consistently sustain high returns on capital which are substantially superior to those of the market.

"Recently the company has seen setbacks due to the Chinese corruption investigation and disappointing second-quarter results, and the shares have underperformed significantly. But although the hiatus in earnings growth may now continue for longer than previously anticipated, the intrinsic value of the company and its pipeline, and respiratory franchise, remains high."