Investors should learn to live with GSK

The fact that the lumbering pharmaceutical firm – or “global biopharma company”, as it now prefers – was developing a vaccine against the virus was incidental. Hopefully, any association will soon be positive, if GSK’s discretely named immunotherapeutic candidate, 3943104A, can move out of the proof-of-concept stage, onto clinical trials, and into a sexual health clinic near you.

At the time, the frustration with the business was clear. By 2021, GSK had held a place in the Bearbull income portfolio for over two decades, and with little to show for it.

This was all before an especially nasty flare-up 17 months later, after small-print disclosures reissued via the spin-out of its consumer arm, Haleon (HLN), precipitated a shareholder tizzy about unquantifiable liabilities connected to Zantac. That this was the drug that once made the fortune of what was then Glaxo, and whose success would never be repeated after the patent expired, only served to underline the feeling of having clung on far too long.

Clung on, that is, through the years of haphazard M&A, financial engineering and finally, when a global pandemic presented the vaccine powerhouse and its investors with a Hollywood-worthy redemptive narrative arc, the failure to grab a position on the Covid-19 jab podium.

But six weeks into 2024, and we have a mini share price rally on our hands. The proximate cause of a 12 per cent rise, against a flat FTSE 100 index, was last week’s decent-ish set of full-year results, next to a better-than-expected set of long-term targets. Read our analysis of those results here.

As to quite what constitutes “expectations” these days, we will unpack. But aspirations are without doubt moving in the right direction. Buoyed by the successful roll-out of its shingles and RSV vaccines, chief executive Emma Walmsley raised mid-term guidance for compound sales growth, adjusted profit growth and margins (see table).

To which we might argue that the bar was too low to begin with. And we shouldn't forget the 25 per cent rise in the cost of goods and services since guidance was last issued in June 2021, and the dilution this inflation has wrought on the value of a sterling-denominated income statement.

Granted, by bumping sales and operating profit growth expectations to 7 and 11 per cent, respectively, GSK is on the right side of the trend in the FTSE 250 index (whose thinner exposure to resources and banks makes for a smoother and more meaningful yardstick than the large-cap index). Still, given the array of moving parts and goalpost-shifting within GSK’s adjusted figures, the lack of an upgrade to operating cash flow generation forecasts stands out.

Greater assurance came from the outlook beyond 2026. The last time long-term guidance was set, investors were told to expect sales for the new-look GSK to climb above £33bn by 2031. Against a 2022 baseline of £29.3bn, this was hardly inspiring stuff, but reflected the looming patent (and cash generation) cliff that would follow the loss of exclusivity on Dolutegravir, the key ingredient in GSK’s HIV medicines, and £5.4bn-worth of sales in 2023.

Now, however, management sees a pathway to exceed £38bn of sales by 2031, all while keeping margins “broadly stable”. Again, my inner cynic wants to cry out that a low, or in this case falling, bar has simply been raised to the level of positive returns. But insofar as we can place faith in seven-year sales forecasts (about which the analyst community has its doubts, as the chart below shows), this is encouraging. After all, if margins can stay high, low sales growth can still lead to a good return on equity.

As to why brokers are yet to buy into the £38bn figure, please see that old mantra of pharma investing: show me the money. Yes, “more than 90 per cent” of the 2031 outlook is accounted for by approved products or product launches planned for the next four years. But what if peak-year sales forecasts prove too heady? After all, bullish assumptions about market size haven’t always panned out, as flat long-term earnings forecasts for 2024 and 2025 show.

The other fly in the petri dish, of course, is the Zantac litigation. That potential liability appears to have narrowed from an initial stomach-ulcer-inducing range of $10bn to $45bn (£8bn to £36bn), which Morgan Stanley once suggested might be due from the drug’s historic manufacturers and sellers, should the courts side with plaintiffs. Simon Gergel, who likes GSK enough to make it the largest holding in his fund, the Merchants Trust (MRCH), reckons the evidence for the plaintiffs “is pretty weak”. Meanwhile, analysts at Berenberg now position Zantac – or rather, its removal as a shareholder concern – as only the third-highest priority in chief financial officer Julie Brown’s 2024 in-tray.

So are falling legal risks the real source of the nascent swing in sentiment? A fifth confidential settlement, this time with a plaintiff in California, was disclosed a day after full-year results. It heads off another trial, without an admission of liability from GSK.

For now, reserving judgment seems the smarter call. Press reports suggest another 79,000 lawsuits have been filed in Delaware. Unpicking the tripwires, about-turns and appeals within the American legal system is only a bit more obscure than the drug approval process itself.

But in the same spirit, I’m going to suspend any doubts about the pipeline, and comparisons with a sector that in certain places rivals the Magnificent Seven for knock-out growth.

Put simply, we shouldn’t judge GSK against the weight-loss industrial complex that is Novo Nordisk (DL:NOVO.B) or Eli Lilly (US:LLY), because it never went down that path. Nor is a specialisation in vaccination without strategic merit. Under normal, non-pandemic circumstances, competition shouldn’t be nearly as high as in oncology, obesity or diabetes, while demand should be supported by the nature of communicative disease and governments keen for the best return on straightened healthcare budgets.

Moreover, I’m finally starting to accept the enormous rates of failure in proper, grown-up science – which should be intolerable for most capital allocators. But from the outside looking in, there has never been a moment to truly write off GSK’s credentials as a science powerhouse. Take the group’s point that more than a third of its 2023 sales came from products launched since 2017. Depending on how you look at it, that very neatly coincides with the start of Walmsley’s tenure or represents a good return on research and development. We shouldn't forget that in the accounting of drug development, failure rarely ever means a total write-off.

Either way, I see lower risks in my own failure to throw in the towel. For one, since last year’s re-capitalisation of the fund, GSK’s weighting has dropped to less than 7 per cent. While a decent slug of an 18-asset portfolio, any drag on returns should be lessened. Second, albeit bone-headedly, I cannot bear the thought of cashing out now only to see the group being digested by a US peer with a clearer commercial insight into its pipeline than I am capable of.

Still, for our purposes, there remains a need to distil this morass of variables into an outlook for the dividend. If the past is any guide, then without income, GSK’s investment case is a wash. In almost a quarter of a century, capital returns to the Bearbull income portfolio have been flat, with almost every penny of return stemming from distributions or my 2022 decision to dump Haleon.

In 2023, the discontinuation of the consumer healthcare division meant the level of dividends technically fell, both in absolute terms and on a per-share basis. This year, investors have been guided to expect 60p across the four quarters, a hike of 3.4 per cent. A bit slight? Perhaps, but this is a well-covered progressive-but-not-aggressive distribution policy, after all. And better than the stasis that characterised the seven years to 2021.

Perhaps a lot more of GSK should have changed since it was added to the portfolio. Thumb through 2000’s low-resolution annual report – the first following the combination of Glaxo Wellcome and SmithKline Beecham – and it was clear then that the consumer healthcare division played second fiddle to momentum in vaccine-led pharmaceutical sales.

But buried beneath it all was, and is, the unlimited potential of smart science. It’s hard to let go of an asset like that.