Are GlaxoSmithKline plc and GW Pharmaceuticals plc simply too expensive?
However much we may like a business, paying too much for the shares will lower our profits at best and lose us money at worst.
After four years of earnings declines, largely caused by a spate of patent expiries, Glaxo is set to return to growth this year. New product sales are kicking in and half-year results last month showed strong momentum in all three of the group's divisions of pharmaceuticals, vaccines and consumer healthcare.
At a current share price of 1,680p, the 12-month forecast price-to-sales (P/S) ratio is 3, the price-to-earnings (P/E) ratio is 16.8 and the dividend yield is 4.8%. I don't believe this valuation is too expensive, and rate Glaxo a buy. If you want to know what too expensive looks like, consider Glaxo's all-time high of over 2,000p -- 15 years ago -- when the P/S was 6, the P/E 28 and the dividend yield less than 2%.
GW Pharmaceuticals was founded in 1998 to develop cannabis-based pain relief products. The company listed on AIM in 2001 with initial target markets of multiple sclerosis (MS) and cancer pain. Its only commercial product to date -- Sativex for the treatment of MS spasticity -- has been selling for over 10 years. Trials continue for a number of other products, with the most advanced being Epidiolex for childhood epilepsy.
The table below shows some key financials for the past 10 years.
|Total revenue (£m)||Sativex product sales revenues (£m)||Net cash flow from operating activities (£m)||Earnings per share (p)|
The majority of group revenue has come from research and development fees from partners, with Sativex product sales revenues representing a small proportion of the total. After early growth in both Sativex and total revenue, no real headway has since been made. However, cash-burn has increased rapidly in the last few years as the company pushes to get further products approved and to market.
Q3 results released at noon today show a continuation of this trend. Total revenue for the nine months to 30 June came in at £8.6m, with Sativex product sales revenues at £3.7m. Operating cash-burn accelerated to £57.2m. On the plus side, GW has stacks of cash on the balance sheet, largely thanks to the enthusiasm of US investors (there have been a number of fundraisings since an IPO of American Depositary Shares on the NASDAQ Global Market in 2013).
So, we have a company whose peak annual revenue to date is £33.1m and whose one commercial product has generated £26m sales revenue over a period of 10 years. How much is GW worth?
The shares are trading at around 600p, valuing the business at over £1.8bn. Taking the peak annual revenue to date of £33.1m gives a P/S of 54 and peak earnings per share of 3.6p gives a P/E of 167. Wow! Remember Glaxo's P/S and P/E when it was expensive?
GW's valuation looks crazy to me. It's priced as if its new childhood epilepsy product Epidiolex is already an approved drug and a nailed-on blockbuster. As such, I can only see this as a stock to avoid on the grounds that it's simply too pricey.
G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.