Is GSK undervalued?

Some high quality companies are undervalued when their dividend yields are 4 per cent, 5 per cent, 6 per cent or even 7 per cent. Others may be equally undervalued on the basis of their historical calculated dividend yields when their dividend yields are just 2 per cent or 3 per cent.

Over time, each company establishes its own barriers where the company is historically undervalued, as well as overvalued, and the same applies to GSK.

Using 1998 as our base year, we have calculated that GSK is historically undervalued at a share price of 1662 pence, yielding 4.13%. GSK is historically overvalued when the share price hits 2419 pence, yielding at 2.77%.

As long as GSK’s share price remains within 10% of its historically undervalued share price, we regard the shares as undervalued warranting a purchase.

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GlaxoSmithKline – A Snapshot

GlaxoSmithKline (“GSK”) is a global healthcare group which is engaged in the discovery, creation, development, manufacture and marketing of pharmaceutical products, including vaccines, over-the-counter medicines and health-related consumer products.

GSK was formed in December 2000 through the merger of Glaxo Welcome and Smith Kline Beecham. The group has around 7 per cent of the world‟s pharmaceutical market.

For many years GSK has been one of the major players in respiratory drugs and these still accounted for 29% of total group sales in 2009 while anti-virals and vaccines made up another 34% of sales.

For the year 2010, total vaccine sales grew 15% to £4.3 billion, including £1.2 billion of pandemic vaccine sales (2009: £883 million).

For years, the geographical split in sales has been biased towards the US and European markets which accounted for over 70% of total sales even though annual sales growth in these regions had slowed to 3% in the USA and 18% in Europe.

For 2010, only 23% of GSK‟s $44 billion in annual sales came from selling pills in Western countries, down from 40% in 2007, while 24% of sales are now generated from emerging markets, which are growing at an 18% per annum.

With the arrival of new CEO Andrew Witty, formerly head of GSK‟s international division in May 2008, the group is steadily diversifying away from a dependency on “white pill/western markets‟ syndrome and instead is increasingly focusing on geographic diversification though a concerted push into emerging and developing markets where it is under-represented, in particular those of Asia-Pacific.

GSK’s earnings from these markets are steadily increasing from 12 per cent to £2.3bn, representing 11 per cent of total pharmaceutical turnover, to 14% in 2010 reaching £3 billion in turnover.

Overall the key drivers for growth at GSK are focused on increasing its presence in emerging markets, expanding the group’s strong vaccine position, product innovation of existing portfolio and the development of new products. Expansion is being targeted through global growth, farm-in deals and selected acquisitions.

GSK is a highly cash generative group, with a strong product portfolio and a proven global marketing and sales team, that is taking firm steps to re-model itself into a more tightly run and more broadly based drug development and marketing business.

GSK has increased its dividend payout each year since 2005 and plans an equally progressive policy for the future. GSK shares are now selling on a dividend yield of over 5% and a price earnings ratio for 2011 of around 10, a long way away from its peak price earnings multiple at 30 times earnings at the end of the century.

Current GSK investors include renowned income fund manager Neil Woodford via his Invesco Perpetual Income and High Income funds, which together own in excess of £1 billion worth of GSK shares, as well as billionaire Warren Buffett’s Berkshire Hathaway.

Berkshire Hathaway bought 1.51 million GSK U.S. ADR shares in the fourth quarter of 2007, around the same time that Andrew Witty was announced as CEO designate.

Based on market prices in the fourth quarter of 2007, Buffett likely purchased his stake between the equivalent of 1,188 – 1,330p, so his current investment is still below break-even at this point.

So long as management is able to increase earnings, while replacing expiring revenue streams – which analysts in aggregate expect – as well as continue with inflation-busting dividend increases, as per Witty‟s comments that the company’s primary use of free cash flow will be ‘towards delivering a progressive dividend’, investors should increasingly appreciate the inherent investment attractions of GSK.


Steven Dotsch, the managing editor of Dividend Income, owns shares in GSK via the Dividend Income Portfolio.

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