Glaxo takes steps to improve long-term prospects

We believe the pharma giant's planned cost-cutting and R&D productivity improvements will enhance long-term prospects

Damien Conover, CFA 10 February, 2010 | 1:16PM
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GlaxoSmithKline reported fourth-quarter results Thursday that largely matched our expectations, and we don't expect any changes to our 1,490p fair value estimate. Glaxo included an update to its strategy along with its results. The company is implementing another round of cost-cutting and improving its research and development productivity. We believe both initiatives will improve its long-term prospects.

Regarding the new round of cost cuts, we believe Glaxo needs to implement these efficiency improvements, as it appeared to be lagging its peer group in cost cuts in 2009. Further, as Glaxo continues to face significant generic competition in 2010, it will need to improve its operating structure to help offset the loss of high-margin drugs. We believe cuts related to sales support on products losing patent protection will give the company new opportunities for savings. Additionally, we believe the marketing support for some of the company's new drugs will require a smaller salesforce as the drugs focus on diseases with smaller patient populations.

Glaxo is also taking steps to improve its research and development productivity. The company is redirecting its drug-development efforts in neurology from pain and depression to neurodegeneration and neuroinflammation. We believe this is a very good strategic move. We believe governmental regulatory agencies are more likely to approve new neurology drugs in these new areas of focus, where very limited treatment options currently exist. Further, the pricing power is much stronger with new neurodegeneration and neuroinflammation drugs versus drugs targeting pain and depression. The company is also taking more aggressive steps to cut products from its pipeline that lack clear differentiation from existing treatments, which should help improve drug approval rates as well as its negotiating power with payers. Lastly, the company is sharpening its focus on orphan diseases, where many opportunities exist and pricing power is very strong.

Glaxo posted 13% year-over-year operational growth in the quarter, led by H1N1 vaccine sales and antiviral drug Relenza. We expect lower sales growth for the company in 2010 as generic competition continues to mount against antiviral drug Valtrex. On the cost side, Glaxo's margins continue to deteriorate as the patent losses on high-margin drugs are hurting profitability. We expect Glaxo's margins to fall further in 2010. However, the new cost-cutting programme should slow the margin erosion.

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GSK PLC1,307.00 GBX0.54Rating

About Author

Damien Conover, CFA  is an equity analyst and associate director at Morningstar.

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