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4 Big Pharmaceuticals Stronger Than GlaxoSmithKline

April 01, 2012 | About:

As of late, there have been direct indications of a conflict arising between Israel and Iran. Defensive plays, such as in pharmaceuticals where companies are largely insulated from petroleum costs can help investors ride out the turmoil. In particular, the limited use of oil and petroleum related products in the manufacturing of pharmaceutical products means that big pharma companies could fare well compared to the rest of market. Indeed, demand for pharmaceutical products is largely inelastic and therefore big pharma's earnings are rarely impinged upon by macro shocks.

One solid example of a defensive play in the pharma sector is GlaxosmithKline (NYSE:GSK). Given that tensions between the two Middle Eastern countries are escalating it is important to analyze GlaxoSmithKline's position in your portfolio if the conflict actually arises. The Intrade prediction market puts the likelihood of an airstrike by the United States and Israel on Iran by the end of the year at nearly 39%. Given the potential of this tail-risk scenario, I am particularly bullish regarding GlaxoSmithKline. As investors move their assets into safe haven currencies like the United States dollar British pound, Glaxo could see an additional relative boost as British manufacturer reporting earnings in its home currency. This might affect both the profit margin and financial stability of the company, but likely only in the short-run.

Outside of its value as a defensive play, I am bullish on GlaxoSmithKline's product pipeline. Its asthma treatment drug Advair had sales grow to $5.6 billion on nearly 21.1 million prescriptions. Likewise, investor expectations of returns generated by the new blockbuster drugs are substantially less than those in the past. The company's earnings multiple has compressed to 10 on a forward basis. Investors have fully discounted the facts that 1) GlaxoSmithKline also has several drugs that are going to lose patent protection and 2) continuing issues with its Avandia product. These two products already had sales decline by nearly 5% over the past year despite being major contributors to GlaxoSmithKline's bottom line. The current price implies much a much steeper sales decline, based of Glaxo's forward multiple.

Indeed, not everything is dour for the world's second largest pharmaceutical manufacturer. The company is trading around $45, near its fifty-two week high of $46.50. The $2.65 dividend payout provides a yield of 6%, which is 1.2% above its five-year average yield of 4.8%. Last year, GlaxoSmithKline made $3.31 per share in 2011, and is projected to increase earnings to $3.71 in 2012 and $4.30 in 2013. The company boasts a 69% payout ratio, indicating that the majority of the company's $33 billion dollars in earnings are returned to equity holders. In regards to competitors, GlaxoSmithKline offers the leading dividend yield within its industry.

The primary reasons for investing in GlaxoSmithKline are the consistent earnings and strong dividend yield offering. With interest rates on US Treasury Bonds low, it is important to find healthy companies that offer value both through earnings growth and dividends. Furthermore, the company has exhibited solid leadership over the past several years and looks likely to maintain its role as a major pharmaceutical producer. GlaxoSmithKline has increased their presence in developing markets, it owns a strong product line, it has the most drugs in the late stage of development out of any pharmaceutical manufacturer, and it was recently selected by investment guru Ken Fisher as strong dividend stock pick. Currently, developing markets have a projected compound annual growth of 13%-16%. Within domestic markets, the retirement of baby boomers should provide an increasing potential market for GlaxoSmithKline. Additionally, GlaxoSmithKline has 26 pharmaceutical and vaccine products in late-stage development. As seen in the case of Pfizer (NYSE:PFE), one blockbuster drug can provide sustained earnings for an incredible period of time.

For those who are looking for a comparable investments with similar dividend yields, I would turn to Abbott Laboratories (NYSE:ABT) or Johnson & Johnson (NYSE:JNJ). Both of these companies offer dividend yields above 3% and have consistently done well in difficult economic times. Abbott maintains a beta of .23 and Johnson & Johnson maintains a beta of .45. Likewise, both of the companies offer healthy dividends and quality earnings that are known to be among the most consistent in the market. These companies are in a healthy financial situation and both look poised to maintain these characteristics moving in to the future. In particular, like GlaxoSmithKline and its competitors, Johnson & Johnson has consistently proven to be a healthy stock inadverse financial situations.

Overall, GlaxoSmithKline is noteworthy for its above average dividend yield and consistent earnings. The forward price to earnings ratio of 27.55 is too low. The industry average price to earnings ratio is 14.7, and competitors Pfizer and Novartis (NYSE:NVS) are trading at 17.25 and 14.49 price to earnings multiples, respectively. Looking forward, I would keep the company on your radar as the risk-off trade returns and favors defensive picks like Glaxo.

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