GlaxoSmithKline woes increase with earnings fall & profit warning

<p>GlaxoSmithKline’s troubles appear to be mounting, judging by its second-quarter results:  sales and earnings tumbled significantly during the period and it gave a profit warning […]</p>

GlaxoSmithKline’s troubles appear to be mounting, judging by its second-quarter results:  sales and earnings tumbled significantly during the period and it gave a profit warning for full-year earnings.

GSK reported this afternoon (Wednesday July 23rd) that sales fell by 13% to £5.56bn, even worse than analysts’ forecasts of weak revenues for the quarter at £5.76bn. Earnings per share (EPS) were 25% lower at 19.1p.

Signalling that GSK’s run of weak quarterly earnings has not yet run its course,  the company reduced its outlook for the full-year of 2014, now predicting that what it refers to as “core” EPS will be “broadly similar” to 2013, adjusted for exchange rate fluctuations.  Previously, Glaxo had hoped to EPS for the year would be between 4% and 8%.

It’s safe to say that Glaxo’s major product issues are a combination of apparent over-reliance on a single portfolio of drugs—respiratory medicines–and competition from generic versions of its drugs.

The main weight on the company’s revenues appears to be from the inhaled lung drug Advair, for asthma and chronic obstructive pulmonary disease.  The product makes up nearly a fifth of sales, but has continued to struggle in the United States, the company said.

The Advair sales decline is symptomatic of the negative trend in the respiratory franchise.  Sales of the category fell 16% whilst those of Advair itself fell even more than the average for the respiratory portfolio—down 19%.

Advair has notably been removed from a recommended list of drugs compiled by Express Scripts Holdings, a US ‘pharmacy benefits management’ firm (PBM).  PBMs are influential companies which act as agents between health care providing companies as clients and drug manufacturers.  Express Scripts now encourages doctors to prescribe drugs which compete with Advair.

Glaxo management expressed surprise in statement accompanying the results that Advair had already begun to face competition from copycat versions in Europe, whilst noting that generic versions in the United States were perhaps just a couple of years away.

GSK recently launched two successors to Advair, the respiratory drugs Breo and Anoro. However the company said the pair had yet to gain significant traction, both posting sales of just £5mn each in the second quarter.

The travails of Glaxo’s product mix have tended to put the spotlight on its strategic direction and more pointedly the Chief Executive Officer, Sir Andrew Witty.

“We have made significant strategic progress during the first half of this year, announcing our innovative 3-part transaction with Novartis and progressing the launches of multiple new products in our core therapy areas of Respiratory and HIV,” CEO Witty said.

“Our strategy to transition and diversify our respiratory portfolio is under way. While sales of Advair will continue to reduce, we expect new products such as Breo, Anoro and Incruse, together with anticipated pipeline products, to generate new sales growth,” Witty added.

However a number of analysts have pointed out that the company’s revised guidance could call put its dividend policy in doubt, especially given GSK’s modest dividend coverage ratio.

GlaxoSmithKline didn’t say much in its earnings release about its legal troubles in China, where GSK faces an investigation by authorities who have alleged “massive and systematic bribery.”  The company merely stated that it continues to co-operate with the investigation.

Even so, whilst the investigation is poses a risk of reputational damage in a growth market, at the moment, China accounts for less than 4% of group sales, thereby limiting the potential damage in the event that Glaxo is ruled to have been culpable.

All in all, it was the collapse in earnings during the last quarter and profit warning that led to the shares falling almost 7% at one point on Wednesday to are 6-year low and a close which was down 4.7% at 1481.5.  The stock fall is likely to further undermine investor confidence and may serve to fan speculation about the tenure of the CEO Sir Andrew Witty.

Witty has appeared to eschew broader strategic trends within the pharmaceuticals sector which have recently led larger drug companies to seek forms of consolidation to reap benefits of scale.

Instead GSK’s CEO has opted for a policy of review of the company’s drug portfolio with disposals of specific parts where deemed necessary. A complex three-part transaction with Novartis over $20bn-worth of assets was one outcome of the review, whilst Witty said on Wednesday there had been “very significant” interest from mid-sized pharmaceutical companies in an auction of mature drugs Glaxo was planning to divest. Witty said he hoped to sell the portfolio of mature drugs, known as established products, by the end of the year.

Despite this, investors might well note the rewards won by investors in Glaxo’s industry peers such as Shire Pharmaceuticals which was bought by Abbvie Inc. for $54bn, landing shareholders about £51.19 for each share owned.

By contrast Glaxo investors were told by the company today that share buybacks over the rest of 2014 were likely to be immaterial.

In a further implicit appeal toward the longer-term priorities of investors, GSK announced a dividend for the second quarter of 19p, 6% higher than a year ago.  The company said in the statement accompanying the results that there was “no change to div policy”.

Overall there was little to increase the attraction of GlaxoSmithKline to value investors from today’s results, albeit fundamentally, its relative valuations are not a great deal worse than they were before Wednesday’s earnings. GSK’s forward price earnings ratio for the next twelve months is at 14.9 according to data from Thomson Reuters, somewhat below the average for a group of its European peers at 15.7, whilst the PE of its direct UK competitor, AstraZeneca, for the same period is 17.6.

From a trading perspective, GSK shares have pierced the lower band of a broad rising trend which commenced in the second quarter of 2008. Furthermore the current share price that closed on Wednesday at 1481.50p is below a 50-day moving average of 1577.32p. The stock price is also below the 20-day exponential moving average in which the effect of short-term price fluctuations is damped. That currently stands at 1555.86. The stock is now approaching levels at which it found good support during a sell-off in 2012, around 1320p. The range between the latter and the 6-year low marked today at 1447.5p, plus the psychologically important market of 1400p are likely to be borne in mind by medium-term traders.

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