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GSK prepares to slim down

Investors get a last, largely unfond, look at GSK before it breaks itself up
GSK prepares to slim down
  • Separation throws up more questions than answers
  • Needs to boost R&D spending significantly

Many longstanding GlaxoSmithKline (GSK) observers will let out a world-weary sigh at the company’s full-year results, as the market prepares to wave goodbye to the original GlaxoWellcome and SmithKlineBeecham merger. So, what has been achieved in the 20 years since the two companies came together in a blaze of publicity? (Tony Blair even inaugurated the new headquarters in West London). The shares are currently worth the same as in 2002, the dividend has been frozen since 2017, the R&D pipeline, apart from one or two bright spots, is thin and uninspiring and the company still has a knack of collecting large contingent liabilities – over £6bn and counting in these results. The question is whether the split into a standalone consumer business with its own listing and an R&D-based company – imaginatively called “new” GSK – can deliver the returns that the old one simply couldn’t.

 

Re-stocking the pipeline

Buried in the detail of the statement is a clue which explains both the current state of the company and the possibility that its long-term fortunes could incrementally improve. A consistent criticism of GSK is that it never spent enough in absolute terms on R&D that its level of sales could support.

While GSK spent an impressive sounding £5.27bn on total R&D in 2021, only £3.57bn of this was in its pharmaceuticals segment, or a roughly 10 per cent proportion of its total sales. By comparison, a general rule for the industry is that pharmaceutical companies must spend north of 20 per cent of sales on R&D just to keep the product pipeline adequately stocked.

Though management can claim that it spent 20 per cent of total pharmaceutical sales on research in 2021, this might not be enough to support a turnaround situation – companies have often upped R&D spending to 25 per cent of total turnover to generate momentum in the product pipeline. Take AstraZeneca (AZN) as an example. It is the type of pure-play pharma company that GSK says it wants to emulate and its spending on research annually is both larger in cash and percentage terms; nearly £6bn, or 23 per cent of total sales. So, taking that as a benchmark, it is easy to envisage that the new GSK needs to increase its R&D spend by a minimum of 25 per cent to catch up with its peers. The impact of all that extra investment is clear; GSK currently has 21 vaccines and 43 medicines in development, while AstraZeneca claims 171, including research on extending individual product lifecycles.

Overall, that means management’s forecast that the new biopharma business will increase its operating profit by a currency-adjusted 12 to 14 per cent, boosted in part from a royalty from Gilead after the settlement of a long-running patent dispute, looks somewhat optimistic. Particularly as the company also makes clear that several years of extraordinary costs lie ahead as it rationalises and reorganises the business after the formal separation. In addition, the gradually reducing demand for pandemic-related medicines means the new company taking an additional hit of between 5 and 7 per cent to operating profits this year.  

 

What now for GSK consumer products?

Now that the consumer products business is to be listed, it begs the question whether this represents a better investment on its own terms than in combination with pharmaceuticals. GSK consumer now has a chair-designate in Sir Dave Lewis who must construct a board for the new company. Having spurned a £50bn offer for the consumer products business, Sir Dave, who interestingly prior to his spell as Tesco (TSCO) chief executive was head of personal products at Unilever (ULVR), needs to prove that taking the spin-out route over grabbing Unilever’s cash was the right option for shareholders. GSK will give a medium-term outlook for the business at a capital markets day later on the 28 Feb. It will be marked as “discontinued business” in the GSK biopharma accounts from the second quarter.  

On the face of it, the consumer business, even without the energy boosting properties of Lucozade (sold to Suntory in 2013) has enough traction to get going on its own, with over £9bn of sales and £2.2bn of operating profits in these results. However, that still makes it a small player when compared with giants like Proctor & Gamble (US: PG) and Unilever itself, though it does not compete directly in the consumer durables market.

With the split coming in the second quarter, those holding GSK shares should continue to do so until there is more clarity on the direction of both businesses. Await developments – hold.

Last IC View: Hold, 1,396p, 11 Oct 2021

GLAXOSMITHKLINE (GSK)  
ORD PRICE:1,651pMARKET VALUE:£ 83bn
TOUCH:1,650-1,652p12-MONTH HIGH:1,737pLOW: 1,194p
DIVIDEND YIELD:4.8%PE RATIO:19
NET ASSET VALUE:424p*NET DEBT:

133%

Year to 31 DecTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201730.23.5031.480.0
201830.84.8073.780.0
201933.86.2093.980.0
202034.16.9711580.0
202134.15.4487.680.0
% change+0.04-22-24-
Ex-div:24 Feb   
Payment:07 Apr   
*Includes intangible assets of £40.6bn, or 807p a share