GlaxoSmithKline (LSE: GSK)and Hikma Pharmaceuticals (LSE: HIK)have been under the spotlight for different reasons this week. The shares of both have risen,yet Hikma is the one that hassent a clear message to investors: as it bulks up, its 10-year rally may last for a very long time..!
Glaxo, meanwhile, must shrink to deliver rapidly rising returns to its shareholders.
Glaxo: A More Aggressive Strategy Is Needed
Glaxos market value has risen 4.5% from its one-year lows since Wednesday, when a decenttrading update confirmed2015 earnings guidance and the outlook for 2016. The HIV and consumer healthcare businesses fared better than the reminder of its portfolio, but its second-quarter results were a mixed bag and analysts did not buy into its story.
S&P Capital IQ, Society Generale and Deutsche Bankjoined those in the bear camp, downgrading the stock soon after the results came out. Going with estimates from these three brokers, the shares would be fairly valued somewhere in the region of1,250p and 1,450p. Glaxo stock currently trades at 1,390p, butmarket consensus estimates assign to it a possible valuation of 1,500p, according to Thomson Reuters estimates.
Theres merit in a view that suggests limited capital appreciation: assuming Glaxo reports underlying operating income at between 6bn and 7bn annually until 2017, while maintaining a steady operating margin at 25% over the period, the value of its stock plus net debt per sharewould be about 12/13 times the value of its forwardEbit. Its underlying profits could be lower, though, which would push up its relative valuation based on weaker fundamentals.Consider that the shares of Shire, for instance, trade at 20x based on the same metric, but on stronger fundamentals.
To achieve a much higher valuation, Glaxo needs to report higher margins, a steeper growth rate for its operating income or a combination of both or, alternatively, it should spin off its prized assets.Otherwise, it may well continue to be a decent yield play the dividend is covered by core earnings but I doubt capital gains could be meaningful.
Hikma is a different story.
Hikmas Stellar Performance
There was always a chance that the shares of Hikma would have enjoyed a great run on the market even before the announcement of its $2.65bn acquisition ofRoxane Laboratories and Boehringer Ingelheim Roxane on Tuesday.
Its core earnings were expected to grow on average at 20% a year into 2017. Which means that, assuming constant trading multiples, its shares could have reach 3,268p from 2,100p the price at which its stock traded before the acquisition of the US specialty generic drugs business was announced.
The deal, which shows a wise capital allocation strategy and an appropriate cash/equity financing mix, contributed to a 15% rise in its stock price this week.
Even though its valuation was already a tad rich before this weeks rise considering the growth rate for sales, earnings and margins since 2013 its seven-year operating performance has been truly impressive, boosted by acquisitions, which play a very important role in its corporate strategy.Consider that since the business was floated in 2005, its stocks performance reads 762%.
It may take less now to record a similar performance.
Frankly, the same applies to another much smaller pharmaceutical company,whose stock has been identifiedas a strong value play by our team of Fool analysts in a new report, which is free only for a limited amount of time!
Astrongtrack record and solidfinancialssuggest that this market darling could become acquisitive or it could even beacquired, offering outstandingreturns to its shareholders, in my view.
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