No Quick Wins for GSK

Walmsley may struggle to maintain the drugmaker's premium valuation.

Incoming CEOs like quick wins. But Emma Walmsley may find them elusive when she takes over at GlaxoSmithKline Plc in March.

Glaxo’s lead drug, Advair, will face competition from generics in the U.S. at some point next year. The pace at which its sales might decline is uncertain. Given it accounts for a quarter of pharmaceutical revenue, the threat is clear.

Investors are turning jittery. After a Brexit-induced surge, the stock has lost 10 percent since October. As money has come out of defensive sectors like pharmaceuticals amid expectations of stronger growth in the U.S., Glaxo has underperformed its European peers.

Walmsley’s strategy isn't yet clear. Her background is marketing not science, adding further doubt to the direction she may take.

Brexit Bargain No More

GlaxoSmithKline is among the more expensive European drugmakers on a forward price-earnings basis.

Source: Bloomberg

Meanwhile, Glaxo's valuation is hardly attractive. On estimated earnings, the company is one of the more expensive of Europe's big pharma groups.

Yield to No One

GlaxoSmithKline has the highest dividend yield of its European peers

Source: Bloomberg

The tempting 5.2 percent dividend yield is deceptive. Analysts are split over whether Glaxo can generate sufficient cash to afford the payout without resorting to extra borrowing.

How can Walmsley defend the valuation and restore some momentum to the shares?

There's no obvious restructuring that could entice investors. Most of the savings from Glaxo's 2015 merger of its consumer and vaccines businesses with those of Swiss peer Novartis AG have already been wrung out. Walmsley ran the consumer side of things with such success it propelled her to the top job.

Some investors want Glaxo to be broken up, with the consumer arm separated from pharmaceuticals and vaccines. But with the first of those businesses locked into a joint venture with Novartis until at least 2018, the only sensible course is to keep all options on the structure open.

Three's A Crowd?

Some want GSK to spin off its consumer arm, which accounted for 25 percent of sales in 2015

Source: Bloomberg

On the dividend, Walmsley doesn't need to do anything urgently. Glaxo has fixed it at 80 pence a share until 2018. The devaluation of sterling has made this more affordable: the U.S. is Glaxo's biggest single market.

Would M&A make sense? Companies with strong share prices and weak cash flow can at least use their stock to buy a cash-generative business.

The snag here is biotechs and drugmakers that could offer a meaningful sales boost are in short supply and high demand. Consider the frenzy around U.S.-based Medivation Inc. or Switzerland’s Actelion Ltd.

That leaves Walmsley one key task: picking winners in the group's pharma business. The coming year is set to see a raft of trial data from Glaxo's pipeline. That will provide a pretext for taking some drugs on to further trials, while scrapping or selling others, and finding potential development partners.

Take oncology. Glaxo's strategy here looks half done. The group sold mature cancer drugs to Novartis, leaving it with a small and early-stage pipeline. That may be worth more to a bigger player in this area -- or require a partner to achieve its full potential. Perhaps being a non-scientist will help Walmsley make these decisions objectively, even if it involves upsetting colleagues early on.

Expectations Gap

Analysts' 12-month forecasts for GSK's stock price are running ahead of its current level

Source: Bloomberg

A little operational improvement coupled with some focus in the pharmaceutical business and perhaps an opportunistic acquisition. It's hardly a grand vision -- but it might be enough to sustain Glaxo's premium valuation in an industry increasingly unloved by investors.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Chris Hughes in London at

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