The era of the giant pharmaceutical conglomerate, which makes everything from throat lozenges to breakthrough cancer treatments, appears to be winding down. In its place is an industry increasingly split between the risky – but rewarding – business of drug development and the steady work of marketing over-the-counter products to consumers. Although the latter category may not come with the glory or growth profile of traditional pharmaceuticals, it is proving its worth as a through-the-cycle investment.
At the start of this month, Johnson & Johnson (US:JNJ) became the latest drugmaker to spin off its consumer health division, now trading independently as Kenvue (US:KVUE). With an initial equity valuation of $41bn (£33bn), the float was Wall Street’s largest in more than a year. Across the Atlantic, GSK (GSK) last week announced it had sold 240mn shares in its former consumer health division, Haleon (HLN), via a placing, upping the free float of its former consumer division.
Following last July’s demerger, the pharma group retained a 13 per cent stake in its spin-off, although the recent sale reduced this figure to 10.4 per cent. Pfizer (US:PFE) also plans to begin shrinking its own 32 per cent stake in Haleon – a legacy of the 2019 merger of its consumer business and GSK’s – within months.
For companies engaged in the costly and lengthy process of developing new prescription medicines, the disposal of a staid consumer-facing division makes financial sense. Margins are substantially greater on newer and more innovative products, which usually enjoy a number of years of lucrative patent protection. Pfizer’s chief financial officer, Dave Denton, recently told the Financial Times that retaining an interest in toothpaste-and-painkillers stalwart Haleon was “not strategic” for the business.
However, Haleon’s first-quarter organic sales growth of almost 9.9 per cent surprised analysts, who had estimated that it would grow 5 per cent. Management now expects full-year organic revenue growth to come in towards the upper end of its previously stated 4-6 per cent range. Pfizer, by comparison, predicts its turnover will fall by 29-33 per cent in the current financial year due to rapidly declining demand for its suite of Covid-19 products. Excluding these, sales are forecast to grow 7-9 per cent.
Problematic as this drop-off is for the company’s investors, it’s arguably the price they pay for exposure to cutting-edge biomedical solutions. Consumer healthcare stocks can’t, by nature, generate the kind of momentum that pharma and biotech companies do. But the likes of Kenvue and Haleon do offer reliable returns while being only minimally exposed to customer cost-cutting behaviours.
According to Bruno Monteyne, an analyst with Bernstein Research, consumer health is one of only two categories that show resistance to both cyclical economic fluctuations and down-trading (the practice of switching to a cheaper brand). The other is pet food. Although they’re purchased infrequently, over-the-counter medicines tend to be bought when in a pinch – and customers are likely to turn to a trusted brand.
“If your hayfever kicks in and you’ve run out of tablets, you’ll go to your nearest pharmacy or supermarket rather than waiting for your next weekly shop,” Monteyne said. “Saving money is not usually at the front of your mind when you’re quickly running to get some medicine.”
Haleon benefits from having a portfolio of recognisable branded products – from Sensodyne toothpaste to Panadol painkillers and Centrum vitamins. The strength of consumers’ connection to these brands theoretically allows the company to raise prices, and maintain profitability, even in times of economic stress. Analysis by Bernstein suggests that Haleon currently has the second-highest Ebit margin among European consumer goods companies, a group that also includes Nestle (CH:NESN) and Unilever (ULVR).
Only Reckitt Benckiser (RKT) can boast of a wider operating profit margin, largely thanks to committed buyers of its infant nutrition products and over-the-counter medicines. In a note published earlier this month, analysts at Jefferies said the best-case scenario for Haleon would see it trading at a higher valuation than rivals. “The precedent for that is how [Reckitt] traded in its ‘glory years’ prior to 2016, where valuation peaked at a price/earnings ratio of 25 times in the spring of 2015,” they wrote. At the current share price of around 343p, Haleon trades on a forward PE ratio of 19 times.
Kenvue’s post-IPO fortunes are somewhat more difficult to predict, given that it hasn’t posted a set of quarterly results yet. The shares did, however, jump 18 per cent on their first day of trading this month. When markets are turbulent, it makes sense that investors might want to retreat to the relative safety of staple health products.
“What makes [consumer health] better than a bond is the fact that investors tend to have inflation protection,” Monteyne said. “Good companies have pricing power and if there’s inflation, they can raise prices. Then dividends and cash will go up in line with inflation.”
