Investment Summary: We see GSK's stock dislocation in 2017 as driven by dividend cut concerns from a potential acquisition coupled with mixed messaging from a new management team and margin headwinds from a large product (Advair) going generic. In 2018, we see margins and revenue growth hitting trough levels and then accelerating in 2019-21 driven by the confluence of Advair generics and the timing of a pretty good pipeline providing optionality to accelerate revenues above current expectations for +2-3% in 2019-20. At current prices, we see +40-50% upside to GSK over the next 3-4 years with support from a 5% dividend yield. GSK's stock performance will depend on clinical trial readouts, execution by management on the communicated capital allocation plan, and execution by management on new product launches across nearly all segments.
Key Metrics to Watch:
Respiratory Segment: -5% growth in 2018 (from Advair generics) improving to +3-4% by 2020
ViiV Segment: +9-10% growth through 2020
Vaccines: +8.5-12% growth through 2020
Consumer Healthcare: +2-3% growth through 2020
Established Products & Other segments: Growth in-line with end markets and consensus
EPS: -5% in 2018 that accelerates to +9-10% in 2019-20 as company moves beyond Advair generics
Detailed Write-Up:
A. GlaxoSmithKline Plc (GSK, $37-39, Mkt Cap: $96B, EV: $110B, Revenue 2017: GBP 31B)
Company Description: GlaxoSmithKline is a UK based bio-pharmaceutical company that operates in three primary areas: Pharmaceuticals, Vaccines and Consumer Healthcare. GSK's bio-pharma business consists mainly of franchises in respiratory and HIV along with smaller franchises in inflammation and oncology. Its HIV franchise is called ViiV, where GSK owns 80% in a JV with minority owners Pfizer and Shionogi. In March 2015, GSK completed an asset-swap with Novartis in which GSK divested its oncology business and took on Novartis' vaccines segment, creating a global consumer healthcare joint venture (Novartis remains a minority shareholder with a 36.5% stake).
B. Idea Classification: Dislocation & Potential Pipeline Inflection
C. Target Price/Downside:
Next 18-24 months trading range: $35-55 (+40-50%/-15%)
Intrinsic Value (IV) Price/Share: 2018-20E: $51, $61, $66 (assume a 70-90% trading range which implies a range of $35-55)
See scenario table
D. Summary Thesis: We see GSK's stock dislocation in 2017 as driven by dividend cut concerns from a potential acquisition coupled with mixed messaging from a new management team and margin headwinds from a large product (Advair) going generic. In 2018, we see margins and revenue growth hitting trough levels and then accelerating in 2019-21 driven by the confluence of Advair generics and the timing of a pretty good pipeline providing optionality to accelerate revenues above current expectations for +2-3% in 2019-20. At current prices, we see +40-50% upside to GSK over the next 3-4 years with support from a 5% dividend yield. GSK's stock performance will depend on clinical trial readouts, execution by management on the communicated capital allocation plan, and execution by management on new product launches across nearly all segments.
E. Conviction Level/Rating:
1/A, Buy, low risk.
Our low risk represents a very diversified product company, good cash flow, and under 2x Debt/EBITDA leverage.
Medium Conviction in $40-45 range
High Conviction in $35-40 range
F. Detailed Thesis: We believe that GSK's recent stock weakness and relative underperformance was driven by dividend cut concerns from a potential acquisition of PFE's consumer segment coupled with mixed messaging from a new management team and margin concerns as its largest product, Advair, sees generic competition. Since the mid-2017 stock dislocation, new management has provided a clear outline for capital deployment, including no change to the dividend policy and M&A that meets hurdles for accretion and an improved cash generation profile (including a potential PFE consumer acq). GSK also provided margin guidance as Advair meets generic competition, somewhat resetting expectations. Between now and 2020, GSK sees low-mid single digit revenue growth and mid-high digit EPS growth. After Advair loses to generics in 2018, GSK has no major patent issues until the mid-2020s.
In 2018, we see margins and revenue growth hitting trough levels and then accelerating in 2019-21. Advair generics is a well understood headwind and the biggest driver of the revenue and margin re-basing. However, we think expectations are missing a pretty good pipeline with optionality to accelerate revenues above current expectations for +2-3% in 2019-20. This pipeline consists of both recently approved products and products in development, including Trelegy, Shingrix, Cabotagravir, and Dolutagravir based regimens in HIV that could change standard of care from 3 drugs to 2 drugs to limit long-term side effects. At current prices, we see +40-50% upside to GSK over the next 3-4 years. GSK also has a 5% dividend yield, which would add +15-20% to the stock return for a total potential return of +40-70%. This will depend on clinical trial readouts, execution by management on the communicated capital allocation plan, and execution by management on new product launches across nearly all segments.
Segment Analysis:
· Pharmaceuticals (£17B): GSK's Pharma segment accounts for almost 60% of total revenues. It is effectively divided between 3 segments: Respiratory (40% of Pharma revenues), HIV/ViiV (25%), and Established Pharma & Other (35%)
o Respiratory (£6.8B): Beginning in 2018, this segment will face headwinds as Advair (£3B) faces generic competition. However, GSK has already launched and is actively shifting patients to next gen products including Relvar/Breo Ellipta and Nucala as well as the recently approved and launched Trelegy (the closed triple). Trelegy has demonstrated meaningful improvements over existing therapies in clinical trials. In Respiratory, we see revenues down 2-5% over the next two years as Advair becomes less meaningful and the next gen products (Trelegy, Relvar/Breo, Ellipta, Nucala) continue to ramp and drive growth in this segment by 2020.
o HIV/ViiV (£4.3B): ViiV represents GSK's HIV segment, which is 20% owned by minority partners PFE and Shinogi. Revenue growth has been very strong (+53%, +21.8% in 2016, 2017) driven by ViiV's strong integrase inhibitor dolutegravir which is sold as a single agent as Tivicay or bundled with two nukes called Triumeq. We expect growth will slow to the high single digit range as GILD will be launching its next gen integrase inhibitor bictegravir. However, bictegravir has shown only non-inferiority to dolutegravir so both companies should benefit as patients switch to next gen integrase inhibitors. We see continued high single digit revenue growth in this segment driven by GSK's robust pipeline of other next gen HIV products in addition to the secular trend of patients switching to integrase inhibitors. These products include Cabotegravir, a longer-acting integrase inhibitor. And, the potential for GSK's two drug regiments if data supports non-inferiority relative to current three drug regimens. Dual therapy provides equal benefits but lower long-term side effects. If dual therapy regimen data continues to look good in P3 as in P2, GSK would be positioned for further growth with a number of dual regimen products ready to go, like the recently approved Juluca.
o Established Pharma & Other(£6B): This segment consists of post-patent medicines in various therapeutic areas that remain very popular in emerging markets. GSK believes they sell nearly 50% more volume than their nearest competition in these markets given strong brand recognition and distribution. This remains a very stable business with flat to slightly up segment growth. Recent pressures have been attributed to divestitures from portfolio management. We model this segment as flat to down over the next 3-4 years but believe it could stabilize earlier.
· Vaccines (£5.2B): GSK's Vaccine business represents about 20% of total revenue and includes vaccines for Meningitis, Influenza, and other legacy viruses. This segment grew +25.6% and +13% in 2016-17 driven mostly by a new vaccine for meningitis. GSK received FDA approval for Shingrix, a vaccine for Shingles. With more than 90% efficacy across all patient types, we think Shingrix could generate +$1B in revenues and displace the legacy product from MRK that is generating +$750M in revenue. We see GSK's Vaccine segment growing +8-12% over the next 3 years driven by Shingrix. We think growth could be better in this segment depending on the ramp of Shingrix.
· Consumer Healthcare (£7.6B): GSK's Consumer segment accounts for about 30% of total revenue. This segment focuses on 4 end markets: Welless, Oral Health, Nutrition, and Skin Health. It includes many well recognized, global brands including Theraflu, Flonase, Panadol, Voltaren, Sensodyne, Aquafresh, Horlicks, Lamisil, and Tums. We see this segment growing in the low single digit range. The PFE consumer business would be a complementary acquisition allowing for greater scale.
Margin Analysis: Over the past 8 years, pre-tax margins have ranged between 25% and 30%. Due to Advair going generic, we see margins reaching below historical trough levels in 2018 (24-25% range) and then rebounding in 2019-20 (25-26% range).
Balance Sheet & Cash Flow Analysis: GSK has $19.0B in debt or $14.2B in net debt on just over $10B in EBITDA. This implies a 1.87x debt/EBITDA range vs peer average in the 2.0-2.5x range. GSK generates over $2B in FCF after the dividend, implying a 0.6-0.7x FCF cover to dividend.
Management/Board/Governance: We see renewed enthusiasm from GSK's new CEO and team that is focused on growth but not disrupting the existing capital deployment strategy. Emma Walmsley has been GSK CEO since April 2017. She was the CEO of GSK Consumer Healthcare, a Joint Venture between GSK and Novartis, from its creation in March 2015 until her appointment as GSK CEO Designate in September 2016. Simon Dingemans became Chief Financial Officer in April 2011 after joining as Chief Financial Officer Designate in January 2011. Simon joined GSK from Goldman Sachs International where he was a Managing Director and Partner. Over the past 6 months, CEO Walmsley has been appointing new people to her executive team.
G. Variant Perception: Key areas of variance vs. investor expectations:
· We see the recent weakness around dividend concerns as a stock dislocation providing a good entry in GSK.
· Fundamentally, we are mostly differentiated in our views in the Vaccines and ViiV segments. We see Shingrix driving above consensus Vaccines segment growth in the +8-12% range (vs. cons +7%) based on clinical data that shows superiority over current Shingles vaccines, . Second, we see ViiV growing in the +9-10% range (vs. cons +6.5-7.0%) based on ViiV's pipeline. We see upside if the dual regimen data shows non-inferiority to current triple therapy.
H. Key Issues & Metrics for Thesis
Respiratory Segment: -5% growth in 2018 (from Advair generics) improving to +3-4% by 2020
ViiV Segment: +9-10% growth through 2020
Vaccines: +8.5-12% growth through 2020
Consumer Healthcare: +2-3% growth through 2020
Established Products & Other segments: Growth in-line with end markets and consensus
EPS: -5% in 2018 that accelerates to +9-10% in 2019-20 as company moves beyond Advair generics
I. Trend: Secular/Cyclical/Internal/Timing (Why now?)
Internal:
Pipeline
Shingrix & Trelegy launches as leading, next gen therapies
Dual regiments in HIV: Data from GEMINI trials could be disruptive to existing HIV care guidelines
Cabotagravir: Longer acting integrase inhibitor in HIV
Secular:
GSK's Vaccines, Consumer Healthcare, and Established Products segments benefit from secular organic growth in the low to mid-single digits for the respective end markets.
Timing (Why now):
Dividend mis-communication and Advair margin concerns have setup GSK at an attractive price point ahead of new launches and pipeline events over the next 6-12 months.
J. Risks:
Timing of Advair generic competition and the potential for deviations from consensus, which sees advair decline of -30% in 2018 and -30% in 2019
Failure of P3 HIV GEMINI study in 1H18 for dual therapy regimens
Failure of P3 HIV study in Cabotegravir
Stronger than expected competition from GILD's bictegravir
Weak launches for Shingrix or Trelegy
Brexit: From a macro standpoint, GSK is based in Great Britain and any issues surrounding a Brexit could impact the stock.
Dividend cut for a high priced acquisition would not be taken well by investors, especially after recent management commentary
K. Catalyst/Inflection:
Mid-18: Clarity on any move for PFE's consumer health business.
Quarterly results with updates to the tax rate and cash flow metrics
2Q18: Potential generic Advair launch
M&A announcements
Sell Side Upgrades
Pipeline:
Shingrix & Trelegy launch updates
2/12/18: GILD's PDUFA for its HIV Next Gen regimen: TAF+Emtriva+bictegravir (single tablet like Triumeq)
April 2018: P3 GEMINI 1 & GEMINI 2 trials: Would validate GSK's two drug approach in HIV naïve patients or low risk patients as an upfront regimen.
Mid-18: P3 data from ATLAS (May) and FLAIR (August) trials in long acting (Q4W dosing) cabotegrevir+RPV(non-Nuke) for HIV by end of 2018
L. Current Sell Side Thoughts:
13 Buys/ 16 Holds/ 4 Sells
M. Financial Model & Scenario Analysis:
Revenue Growth:
