2022 was a landmark year for GSK, with the Group completing the demerger of its Consumer Healthcare business (Haleon). The IPO of HLN was almost derailed by a takeover approach by Unilever, which indicated a willingness to pay up to £50bn for HLN. It is not clear that ULVR shareholders would have supported a bid at that level, but I suspect many GSK shareholders (including this one) would have happily sold there – on 18 July HLN started trading at £3.30 a share, giving a market cap of £30.5bn – and adding in net debt of £10.7bn on that date gives HLN a starting enterprise value of £41.2bn, 18% below the indicative ULVR offer (the variance likely reflects a change of control premium and/or the synergies that ULVR would have extracted from HLN. My more detailed thoughts on HLN are available here.
The demerger of the Consumer Healthcare business has made GSK a more focused Group, concentrating on vaccines and medicines.
In FY 2021 GSK (including the now-Haleon) reported sales of £34bn and adjusted operating profit of £8.8bn. Excluding Consumer Healthcare, the continuing GSK business contributed £24.5bn of revenue and £6.6bn of adjusted operating profit. It should be noted that of the £24.5bn of revenues, £1.4bn of this related to COVID-19 solutions.
In June 2021 management gave a presentation on ‘New GSK’ (i.e. GSK minus Consumer Healthcare). This set out an ambition for CAGR of more than 5% sales and 10% adjusted operating profit over the 2021-26 period. Taking the actual FY 2021 performance and adjusting for Consumer Healthcare as the starting point (i.e. revenue of £24.5bn and adjusted operating profit of £6.6bn), this gets to 2026 sales and adjusted operating profit of £31.3bn and £10.6bn respectively.
The market appears to concur with this guidance, with consensus for 2025 settling at revenues of £32.8bn and headline (pre-adjustments) operating profit of £9.8bn. As discussed later in this piece, GSK has made a number of acquisitions recently, which likely explains some of the (positive) variance between sell-side expectations for 2025 and management’s own guidance for 2026.
GSK released its first set of results (for Q322) post the HLN demerger at the start of November. These showed broad improvement in the top-line across all divisions, with Specialty Medicines revenue of £2.7bn +24% at constant FX rates; General Medicines revenue of £2.6bn +1% at constant currency; and Vaccines revenue of £2.5bn +5% on the same basis. It should be noted that the £7.8bn of reported revenue benefitted from a currency tailwind of £0.6bn and pandemic-related revenue of £0.2bn, nonetheless, excluding both of these items shows underlying revenue of £7.0bn in the quarter, +7% at constant FX rates versus the same period in the prior year.
Year to date (to end-Q322) revenue of £21.9bn and adjusted EPS of 113.9p were +19% and +20% respectively. Management again raised its FY guidance at the Q3 results to sales growth of 8-10%; adjusted operating profit growth of 15-17%; and adjusted EPS growth c.1% below the rate of adjusted operating profit growth (i.e. 14-16%). At the time of the Q2 results management had guided to sales growth of 6-8% and adjusted operating profit growth of 13-15%, with the same delta in EPS growth as in the refreshed guidance. It is encouraging to see the pace of growth in both the top-line and adjusted operating profits tracking above the guidance set by management out to 2026.
There are two key growth avenues for GSK, R&D and ‘strategic business development’ (M&A and partnerships). On the latter, GSK completed two significant acquisitions in the second half of 2022. The Group bought Affinivax, a clinical-stage biopharmaceutical company focused on pneumococcal vaccine candidates, for an initial £1.8bn (up to a further £1.0bn is payable, conditional on the achievement of clinical development milestones); and Sierra Oncology, a late-stage biopharmaceutical company focused on targeted therapies for the treatment of rare forms of cancer, for £1.6bn. In addition, GSK signed a licence agreement with Spero Therapeutics to give it “exclusive access to tebipenem HBr, a late-stage antibiotic that may treat complicated urinary tract infections”.
There has been a lot of focus on GSK’s R&D pipeline. A May 2020 article in the FT (‘Drug Wars: How AstraZeneca overtook GSK in UK pharma’) noted that: “AstraZeneca’s success has put GSK under even more pressure to demonstrate that it can pull off a similarly durable R&D-led revival after years of failing to develop a cadre of new blockbuster medicines, despite a healthy number of regulatory approvals”. GSK’s innovation focus is on four therapeutic areas – Infectious Diseases; HIV; Immunology/Respiratory; and Oncology. At the end of September GSK had a pipeline of 65 potential new vaccines and medicines across Phase I; Phase II; and Phase III/Registration.
The Group has been stepping up its investment in R&D in recent years. The Group expensed £4.6bn (equivalent to 13.5% of that year’s revenue) on R&D in 2019; £5.1bn (15.0% of revenue) in 2020; and £5.3bn (15.5% of revenue) in 2021. The combined £15bn of R&D spend over those three years is equivalent to around a quarter of GSK’s market cap, hinting that the market is likely not betting big on the pipeline. GSK’s Q322 results show a year to date R&D spend of £3.7bn, up from £3.6bn in the same period in 2021.
I won’t pretend to be an expert on the science, but I do draw reassurance from the volume of recent updates regarding the pipeline in Q422 and also the steady uptick in R&D spend in recent years.
One particular highlight was October’s announcement of Phase III trial results for GSK’s RSV vaccine candidate. These found a 94.1% reduction in severe RSV disease and overall vaccine efficacy of 82.6%, with a favourable safety profile. While Pfizer also has a promising RSV vaccine candidate (for good order, Moderna is due to release the first interim analysis from its Phase III RSV vaccine study in the near term), the fact that RSV did not have a vaccine before now suggests that the addressable market will be more than big enough for a number of players to compete in – RSV causes over 420,000 hospitalisations each year and 29,000 deaths in adults in industrialised countries. GSK has made regulatory submissions in respect of its RSV vaccine in Japan, the EU and USA.
Other R&D highlights in Q4 include: (i) Sanofi and GSK’s next-generation COVID-19 booster vaccine VidPrevtyn Beta being approved by the European Commission; (ii) the European Medicines Agency accepting marketing authorisation application for momelotinib for the treatment of myelofibrosis (a rare blood cancer); (iii) the Jemperli (dostarlimab) RUBY phase III trial meeting its primary endpoint in a planned interim analysis in patients with primary advanced or recurrent endometrial cancer – regulatory submissions based on the trial results are planned for H123; and (iv) while GSK initiated the process for withdrawal of US marketing authorisation for Blenrep on foot of a US FDA request, additional trials are planned to determine the potential benefit of its use in combination with other treatments for multiple myeloma (a more common type of blood cancer).
One issue that weighed on the share price for a large part of 2022 was litigation risk around a previously owned drug (Zantac). December saw a significant ruling in the federal Multi-District Litigation in the US, where the court sided with the scientific consensus, which is that there is no consistent or reliable evidence that ranitidine increases the risk of any cancer. This doesn’t draw a firm line under the Zantac matter – there is the possibility of an appeal of this ruling, while other cases are being taken at the State level – but the 7.5% one-day jump in the share price that followed the ruling (adding £4bn to GSK’s market cap) indicates that the market believes the risks from Zantac are reducing.
Let’s turn to the GSK balance sheet. The Group had £60bn of assets at end-September, of which ‘Other Intangibles’ (intellectual property) were £16bn; PPE £9bn; Goodwill £7bn; and ‘Current Equity Investments’ (Haleon) £3.5bn. It should be noted that the Haleon stake isn’t entirely ‘free funds’ for GSK – the Group has a direct interest (worth c.£1.6bn at the current HLN share price) while a further c.£2.3bn of HLN stock sits in Scottish Limited Partnerships tied to GSK’s pension schemes. However, the fact that the current HLN stake value is higher than the latest book value is a positive, although mark-to-market moves are going to inject some unhelpful ‘noise’ in GSK results reporting so long as it remains on the HLN register. Another point of note on the asset side of the balance sheet is that GSK is currently marketing its ‘old’ HQ in West London for sale – it’s a 690,000 sq ft building that I’ve previously estimated could be worth around £345m (granted, this isn’t a good time to be trying to shift a jumbo commercial real estate asset in the UK) – ahead of the Group’s move to much smaller (140,000 sq ft) rented accommodation in central London.
On the liability side of the balance sheet, I note that the end-September on-balance sheet pension deficit was £2.9bn. Post the balance sheet date, and in response to market volatility in UK gilts in October, the Group injected £334m in voluntary cash contributions to two of its DB schemes. The Group had net debt of £18.4bn at end-September, down £1.4bn from end-2021, and this is an undemanding 2.0x multiple of the £9.2bn sell-side consensus EBITDA forecast for FY22.
Turning to distributions, at the June 2021 ‘New GSK’ investor update management set out that, from 2022, a progressive dividend policy would be implemented, guided by a 40-60% payout ratio throughout the investment cycle. Adjusting for last year’s share consolidation, management now guides to an expected dividend for 2023 of 56.5p. This equates to a yield of 3.9% at the current share price. Given management’s medium-term growth ambitions, this dividend is likely to increase steadily from here.
Bloomberg consensus, shown here, assumes that GSK will deliver revenue of £32.8bn in 2025 and headline operating profit of £9.8bn in the same year, suggesting that management’s medium-term guidance (to 2026) is reasonable. Beyond that, there is a material threat to GSK sales and earnings, with the loss of exclusivity for Dolutegravir kicking in. GSK’s family of Dolutegravir medicines contributed £4.6bn of revenue in FY21, or about 19% of that year’s total, excluding Consumer Healthcare.
In my view, management isn’t over-promising when it comes to the risks from the loss of exclusivity on Dolutegravir. The New GSK presentation guides to £33bn of revenue in 2031, while it also guides to CAGR in sales of 5% over 2021-26, which gets you to about £31bn of revenues of 2026. So, in real (inflation adjusted) terms, the GSK guidance assumes flat revenue between 2026 and 2031. This might sound unexciting to readers, but with operating margin guidance of >30%, this still implies that GSK will do c.£10bn of adjusted operating profit a year over the period.
To this end, it is worth noting that as 40-60% of earnings will be distributed out to shareholders, looking at the R&D pipeline (65 medicines and vaccines at end-September 2022), I wouldn’t bet against management being able to create more value with the other (say) 40-60% of earnings in the period.
GSK trades on a very undemanding multiple of just 9.8x expected earnings. This suggests to me that very little is being priced in by the market in terms of its growth prospects. Indeed, GSK is only trading in-line with the broader UK market and at a discount to large cap pharma peers – Koyfin data show that AstraZeneca is on 19.6x forward PE; Sanofi on 10.8x; and Pfizer is also on 10.8x.
What will it take for GSK to trade in line with the peer group? I think the market is saying ‘show me’ in terms of the GSK pipeline. Further successes here will be the catalyst for a re-rating in my view. In the meantime, the discount at which GSK trades at relative to peers suggests limited downside risk to me here. I like GSK here and am a happy holder.
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