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Glaxo Q3 results – in need of more treatment

GlaxoSmithKline (GSK) issued its 3rd Quarter Results today (22 Oct 2014). It’s one of those large FTSE-100 stocks that it’s difficult to avoid holding if you are a UK stock market investor. It’s such a large constituent of the index that all those index funds, and indeed almost all generalist unit or investment trusts, are likely to have a big stake in them. It’s also one of those stocks that many people hold directly (as does this writer) simply as a defensive stock with a high dividend yield – currently 6%. People will always need medication and with an ageing population they may need more is how the argument runs.

The announcement was moderately positive at first glance as it had a headline stating that Core EPS was up 5% at Constant Exchange Rates excluding divestments, and mentioned a dividend of 19p. What does “Core EPS” mean? In reality it’s all the stuff they prefer to exclude. Here’s the definition given on page 26 of the results: “Core results exclude the following items from total results: amortisation and impairment of intangible assets (excluding computer software) and goodwill; major restructuring costs, including those costs following material acquisitions; legal charges (net of insurance recoveries) and expenses on the settlement of litigation and government investigations, and acquisition accounting adjustments relating to the consolidation of material acquisitions, disposals of associates, products and businesses, other operating income other than royalty income and other items, together with the tax effects of all of these items”.

As is usual of late with Glaxo, there are more restructuring announcements which are typically some of the bigger items that make up the above list. So in the latest news it mentions a “catalyst to fundamentally re-shape GSK”, a “new executive management structure”, the spin off of their HIV business and a “refocus” of their global pharmaceuticals business and cost base. All of this no doubt means more exceptional charges in future, in addition to those incurred in the last quarter.

Looking at the reported financial information and ignoring all the above sophistry, earnings per share fell by 58% over the same quarter in the prior year, and the first 9 months of the year they fell by 41%. That’s not so impressive is it! Even worse is apparent when you look at cash flow, because a lot of exceptional items such as writing off historic costs have no impact on cash.  Net cash flow from operating activities for the first 9 months is also down 41%.

The dividend is “maintained” at 19p per share this quarter and they expect the full year dividend to grow by 3%, but next year (2015) they only expect to maintain it at the same level. But perhaps as compensation they do plan to return £4bn to shareholders in 2015 via a B share issue (current market cap is about £65bn) following completion of the Novartis deal.

This writer is not particularly competent to judge the merits of the company’s future drugs pipeline and as is usual with GSK announcements there are positive noises in there about that. But we have surely been hearing this for a few years now and the results seem to be slow in appearing.

The key question that investors need to ask themselves is “does this look like a healthy business”? Looking at the share price trend over the last few months clearly many have come to the conclusion that it does not. New Chairman Sir Philip Hampton (from a similar tough job at Royal Bank of Scotland) will need to take some strong medicine to sort out this business. But unfortunately he does not seem to have any background whatsoever in the pharmaceutical industry. Let us hope he learns quickly.

One bit of positive news in the announcement is that GSK is working hard to develop a potential vaccine for Ebola and they have a candidate in the pipeline. But unless Ebola spreads to western and other developed countries, which now seems unlikely, there may not be great profits from that.

In conclusion GSK is a patient some way from recovery by the look of the latest figures.

Roger Lawson

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