June 16, 2020
The saying ‘prevention is better than cure’ has been a staple repertoire of some of the largest pharmaceutical companies. With the current pandemic disrupting the day-to-day lives of people all around the world and costing economies billions of dollars, investors are looking to direct their money towards pharmaceuticals in the hopes of striking the proverbial goldmine: the COVID-19 vaccine.
GlaxoSmithKline (GSK), the London-based science-led global healthcare company has been one of the forerunners of producing adjuvants - additives to an existing vaccine that boost the body’s immune system. Using an adjuvant will mean that fewer antigens are required per vaccination, while also making them longer lasting, resulting in more doses being available to protect people around the world.
To pick winning companies, it is important to analyse a company’s quality as this factor helps identify companies who have the capability to withstand tough market conditions and continue to generate income whilst operating efficiently. The three factors that go in hand when analysing quality are growth, profitability and capital allocation.
GSK’s operating profit in the last four quarters has not been on a continuous upward trend. However, as expected by analysts, operating profit increased in the latest quarter as infections and diseases resulted in more customers purchasing various drugs to combat sickness. According to the latest quarterly report, the spike in operating profit was due to a year-on-year increase in sales across all three business segments; pharmaceuticals, vaccines and consumer healthcare.
With a consistent track record of paying dividends every quarter, GSK still manages a 12.6% YoY revenue growth. GSK is one of the top two companies in the FTSE100 by market capitalisation and 6.9 million shares traded on a daily basis. It has stated that it will pay shareholders 19 pence per share (payable July), down 17.4% from the previous quarter as earnings are being reinvested into R&D for the adjuvant COVID-19 vaccine.
The pharmaceutical giant has announced its goal to produce 1 billion doses of the pandemic vaccine adjuvant in 2021, to support multiple COVID-19 vaccine collaborations. Why is GSK coming up with an adjuvant and not the vaccine itself? This is because GSK is the leader in the development of innovative vaccines using different adjuvant systems, and they see themselves as a powerful partner to companies who have already made promising breakthroughs in developing COVID-19 vaccines. This effectively means that GSK will be involved in the manufacturing of COVID-19 vaccines, no matter which company develops the drug first. Forming strategic partnerships with companies such as Clover, Vir Biotechnology, Sanofi and various scientific partners in North America, Europe and China to develop vaccines will allow GSK to reach their goal faster and help save lives as soon as possible.
To measure profitability, operating profit margin is a good metric for benchmarking a company against similar companies within the same industry. This shows how well the company is performing against its competitors and whether it is beating the industry’s average benchmark. When it comes to pharmaceutical companies, operating profit margins in the double digits indicate that the company has strong management. Although GSK does not have the best margins compared to Pfizer and Roche, they are still a highly profitable company and have excellent margins (see below). With new partnerships in the works across the world, operating margins will increase, with synergies expected to reduce operating expenses.
Moving on, GSK’s Return on Equity (ROE) (net income over shareholder equity) has declined over the past four quarters and is currently 8%, which is below the 10% industry benchmark. Generally, an ROE which is below 10% indicates that the company’s management is not using the company’s assets to generate profits effectively.
There was a significant difference between Q2 2019 and Q3 2019 as ROE decreased by 25%. Based on the below breakdown, total assets increased by 31% while total liabilities increased by 7%. Consequently, total equity increased by 509%, resulting in shareholder equity dilution. GSK’s ROE does not look promising given that the company has such a strong balance sheet and investors should be wary of this.
Earnings per share (EPS) is another long-term investor favourite, used to measure profitability by indicating how much money a company makes per share. Companies with higher EPS indicate higher levels of profitability and vice versa. Over the last four quarters, GSK has consistently seen its EPS increase and this figure is currently at an all-time high of 31.5 pence per share. Ultimately, the company has kept up with the demand for their other medicines, despite supply chains around the world being disrupted. Going into the 2nd quarter of 2020, EPS is forecasted to increase, with the demand for medicine being anticipated to increase to unprecedented levels.
Capital allocation measures a company’s ability to distribute its financial resources to generate income as efficiently as possible. In the pharmaceutical industry, a huge proportion of funds are normally injected into R&D, to stay ahead of competitors by developing new medicines. GSK is a highly profitable company, despite pumping in 20% of its revenue into R&D. So just how effective is GSK’s management in allocating capital, while weathering the current pandemic?
The best pharmaceutical companies are those that are most innovative. As new diseases are constantly occurring, R&D is needed to develop new drugs and expand the product line. How have GSK’s R&D efforts translated into sales? The average R&D to Sales ratio across the four latest quarters is 12.87%, with the latest quarter performing worse than expected. As a whole, the healthcare industry’s R&D to sales ratio averages at 16% so GSK falls quite a long way short of that benchmark. Be that as it may, GSK is focused on partnerships to combat this pandemic, as they are aware that they cannot go it alone, which should increase their chances of developing the long-awaited drug.
Evaluating CAPEX (Capital Expenditure) to Sales (Property Plant Equipment + Capital Assets divided by Sales) will indicate how aggressively the management is reinvesting revenue back into high-yielding assets. The CAPEX to Sales ratio has declined by 60% from 5% to 2% in the last two quarters. Perhaps the latest investment efforts amounted to little. In the pharmaceutical industry, CAPEX to Sales should be above the 5% benchmark and anything below this is perceived as poor.
Finally, based on GSK’s historical dividend payout ratio (DPR), a metric that represents the proportion of earnings paid out as dividends and the amount retained by the business to pay any outstanding debts, the company has consistently increased its payouts to shareholders in the last four quarters. In the latest quarter, GSK paid out 40% of net income and retained the remaining 60% in the business, a sign that the company can meet shareholder needs even during the current health crisis.This year, GSK is forecast to pay-out 74.7% of net income, a new low compared to the last 5 years. However, this 74.7% is still well above the average industry benchmark of 60%.
Based on Genuine Impact’s ranking, GSK is ranked at #3,749 for quality and is one of the lower-ranking stocks in our stock universe. Although the profitable pharmaceutical giant is the world’s largest vaccine maker and is one of the favourites to discover and manufacture the COVID-19 adjuvant vaccine first through partnerships, its competitors AstraZeneca, Pfizer and Roche have better quality rankings. GSK does not need to need to participate in the COVID-19 vaccine manufacturing/development race to survive this impending recession. However, manufacturing one will reel in massive profits and allow the company to grow exponentially. Assuming GSK is successful, share prices are predicted to increase drastically with plans to roll out 1 billion doses in 2021. If investors are willing to bet on GSK coming up with the adjuvant first then based on the company’s reputation and their strong historical dividend payment history, GSK is worth considering.