by Dan Burrows | October 8, 2013 12:22 pm
Forget about sharks, cobras or crocodiles. The world’s deadliest animal is the lowly mosquito, in no small part because it transmits malaria. More than 200 million people are infected with the malaria parasite every year, according to the World Health Organization, and the disease proves fatal for about 650,000 of them.
Fortunately, GlaxoSmithKline (GSK) is on the case. The British pharmaceutical giant is seeking regulatory approval for the world’s first malaria vaccine.
Trials conducted in Africa, where most new malaria cases occur, show promise. GSK’s vaccine cut the number of malaria infections in young children by almost 50%. Yes, that leaves huge room for improvement, but it’s a start.
Malaria is an enormous scourge, but even if Glaxo’s vaccine gets approved, it does nothing to address most of the company’s biggest challenges, like leverage and low growth.
So, should you buy GlaxoSmithKline stock? To help decide, let’s look at some of the pros and cons of GSK:
Ballast: Bonds help tamp down volatility in your portfolio by acting as a counterweight to stocks. To further reduce risk, it’s a good idea to add some low-volatility stocks to the equity side of holdings. GSK very much fits that role. With a beta of 0.6, it can be thought of as 40% less volatile than the S&P 500. That will help cushion any blow in a market downturn.
Income: GlaxoSmithKline is committed to keeping shareholders happy by returning a good deal of cash. Not only is the company buying back as much as $3.2 billion worth of its stock this year, but GSK boasts a hefty dividend to boot. At current share prices, the forward yield on the payout comes to 4.4%. And that income is something you should be able to bank on, considering GSK has made returning cash to shareholders a key priority.
Innovation: Pharmaceutical giants live and die by research & development. Patent protection on blockbuster drugs eventually expires, at which point cheap generics start to eat their lunch. That’s why it’s critical to have lots of promising new drugs in development. GSK has a healthy product pipeline, especially with a newly approved HIV drug that could be a big earner.
Leverage: GSK carries a truly epic amount of debt. Indeed, the company has nearly $16 billion in long-term debt and nearly $30 billion in total liabilities. To put that in perspective, GlaxoSmithKline has $256 in debt for every dollar in shareholder equity. That’s a heavily leveraged balance sheet. True, GSK has a good credit rating and pays a competitive 4.5% on its borrowings, but it has to clean up its balance sheet.
Pricey Shares: With a forward price-to-earnings ratio of 13, GSK is only slightly cheaper than the broader market despite having nowhere near the same growth prospects. Nor does it offer any kind of discount to its peers. Then there’s the price-earnings-to-growth ratio, which shows how fast a stock is rising vs. its growth prospects. With a PEG of 3.5, GlaxoSmithKline stock has gotten far ahead of future earnings.
Stagnation: The valuation measures mentioned above are out of whack because GlaxoSmithKline stock has such tepid growth prospects. Analysts project the company to grow earnings by about 4% a year for the next five years. The S&P 500, meanwhile, has a long-term growth rate of more than 9%. GSK is an ATM, not an earnings machine, which makes paying 13 times forward earnings a stretch.
The generous dividend and low volatility have their appeal. If GlaxoSmithKline stock were better at price appreciation, we could almost recommend it as a bond in drag. Add in the dividends, and GSK’s total return for the year-to-date matches the total return for the S&P 500.
Longer-term, however, its total return lags that of the broader market by a wide margin. GSK simply doesn’t have the earnings growth to keep up.
What dividends give, flaccid price action takes away. When it comes to equity income, there are better stocks to buy than GSK.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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