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LONDON (Alliance News) - Broker Liberum has cut its recommendation on pharmaceutical giant GlaxoSmithKline PLC to Sell, and cut its price target to 1,350 pence from 1,500 pence, warning that things at the company will "get worse yet."
Glaxo is trading up 1.2% at 1,431.50 pence Tuesday.
Liberum said that the immense pressure the company is under is likely to lead to underinvestment in its core areas. It warned that "despite the smoke and mirrors, GSK is still a pharma business with no pipeline or innovation."
Whilst Glaxo's three-part deal with Novratis might make it look more diversified, Liberum said that by its analysis, pharmaceuticals will still account for 73% of earnings in 2016.
Liberum expects the company's respiratory franchise to decline to 2019, and will decline every year including the next three years, despite additional revenues from new products Breo and Anoro.
Liberum is below consensus on both products, and believes that Glaxo's key product, asthma and chronic obstructive pulmonary disease treatment Advair will decline at 20% next year.
Glaxo lowered its full-year earnings per share expectations at its interim results last Wednesday, saying it now expects them to broadly similar to 2013. The company's pretax profit declined in the half year, hit by generic competition to its products, particularly in the US. Sales of Advair dropped 25% in the US during the half year.
Liberum has cut forecast to 91 pence earnings per share for the year, and warned that the "greatest uncertainty surrounds the dividend." The broker believes that the dividend is safe for the coming year and a half, however, it could be at risk.
It expects Glaxo's selling, general and administrative expenses to remain flat in 2014 to 2016 following the Novartis deal; although Glaxo stands to gain cost synergies from the deal, the acquired businesses could add around GBP1.2 billion in selling, general and administrative costs, Liberum warned.
This means it would have to cut around GBP400 million in costs from its existing business, which could lead to further underinvestment and cuts to sales forecasts.
"If they don?t cut the cost then forecasts will fall and the payout ratio will remain unsustainable," Liberum said.
Liberum forecasts that Glaxo's research and development costs will fall to just 10.9% of sales in 2019, as it becomes a relatively low innovation business.
Risks to GlaxoSmithKline's dividend include the company's operation outlook worsening, a substantial deal - although Liberum considers this difficult to do given the company's current cash position, its costs lines are rebased, or a new strategy is announced to rebase its expectations.
"If a change in strategy leads to a rebasing of expectations and/or reverses the disinvestment in the business or the earnings outlook worsens, we believe the dividend is at considerable risk. We believe that management may be hesitant to invest fully in the business because of the pressure the dividend is under," Liberum said.
Liberum blames a combination of pipeline failures, and competition or pricing pressure on existing drugs key drivers, alongside Glaxo's failure to innovate.
"Lack of innovation over the last few years is now manifesting in consistent margin pressure and lacklustre sales growth," Liberum said. It cited the company's shrinking pipeline, and noting that the company's recent phase III success rate is just 47%, below the industry average of 70%.
Unfortunately for Glaxo, Liberum does not think there's a simple route to fixing its problems.
"Either cut the dividend or increase debt to make sure that the existing franchises don?t disappoint further. If they don?t stop the declines the dividend becomes unsustainable in 2-4 years time," Liberum said. Liberum also highlighted the possibility of spinning off its consumer healthcare operations once it has integrated the business and achieved the synergies, which it could use the proceeds from to do a large merger or acquisition.
The possibility was raised by Glaxo's Chief Executive Andrew Witty in an interview with the Financial Times Sunday, although Witty made it clear there were no plans to do so in the near term.
By Hana Stewart-Smith; hanassmith@alliancenews.com; @HanaSSAllNews
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