News that US pharmaceutical giant Pfizer is planning to sell its consumer healthcare division and that GlaxoSmithKline (GSK) may decide to buy it, overshadowed the latter’s third-quarter results. Investors have previously criticised the UK group for prioritising toothpaste over potentially life-saving medicine and seemed unimpressed when chief executive Emma Walmsley confirmed her interest in building up its consumer business. The shares dropped by as much as 6 per cent on the day of the announcement, despite it posting consensus-beating pre-tax profits during the three months to September 2017.
Ms Walmsley – who previously headed up the group’s consumer healthcare business – said that, as a world leader in over-the-counter medicines and health products, “you would expect us to look at any assets that complement our portfolio”. Pfizer’s healthcare division – which includes brands such as Advil pain relief and ChapStick – certainly looks a good fit. In 2016 it racked up $3.4bn (£2.6bn) of sales.
But GSK is unlikely to be the only company interested in Pfizer. Reckitt Benckiser (RB.) has also confirmed it would consider buying the business, which analysts think could fetch as much as $15bn. GSK’s investors are likely to be worried about what such an acquisition would do to the balance sheet. The group’s £4.7bn cash pile is nowhere near enough to cover the acquisition and net debt at £14.2bn is already stretched to over 1000 per cent of shareholder equity. Worryingly, the balance sheet appears to be the only thing keeping the dividend afloat. The 80p-a-share annual payout has not been covered by earnings or free cash flow since 2014.
GSK is already entangled in a consumer healthcare joint venture with Swiss pharma group Novartis. Under the terms of the contract, Novartis has the right to force GSK to acquire its 36.5 per cent holding any time between 2018 and 2035. At the moment, this so-called put option is recognised as a £7.4bn financial liability on the balance sheet. However, if Novartis exercises its rights (which is likely if GSK decides to buy Pfizer’s consumer business), the buyout will be reflected within the group’s free cash flow. Considering management recently changed the dividend policy to reflect free cash flow instead of earnings, investors have every right to feel nervous about the sustainability of the dividend.
The potential acquisition is also in stark contrast to the group’s current pharmaceutical focus. Although Ms Walmsley reiterated her intention to prioritise investment in drugs in the third-quarter results, research and development expenditure of £1bn was below previous expectations and substantially short of the average three-month expenditure by many big pharma peers.
Newly launched medicines, including the Breo and Anoro inhalers have also failed to perform as hoped. Although prescriptions of these two products rose 74 per cent and 70 per cent respectively during the reported period, pricing problems dampened revenue growth. Although management suggested this is merely a short-term issue with insurer rebates, pricing trends in the US are not favourable. A proposed clamp down on the cost of commonly used medicines – especially respiratory and cardiovascular treatments – would hurt the product areas in which GSK currently excels. Outside of respiratory, its new drugs pipeline is uncomfortably empty.
GSK continues to rely on its top-selling drug, Advair, which contributed 9.5 per cent to the top line during the third quarter. This asthma medicine has already lost its patent protection and there are several unbranded competitors awaiting regulatory approval from the US food and drug administration. As none of these is due to hit the market before the end of the year, 2017 earnings are expected to rise between 3 per cent and 5 per cent. But next year the entry of unbranded competitors is expected to hammer Advair sales which, in turn, will hurt EPS. Broker Liberum has forecast adjusted EPS of 110p in the year to December 2018, down from an expected 112p during the current financial year.
