Hikma Pharmaceuticals plc's pain could be GlaxoSmithKline plc's gain
Hikma Pharmaceuticals(LSE: HIK) today downgraded its 2017 forecast for the third time this year and now expects revenues of around $2bn, down from previous guidance of $2.1bn-$2.2bn. The announcement of a licensing agreement with Takeda couldn't prevent the shares from plummeting 9% in early trading, knocking the share price down to nearly half what it was just 12 months ago.
The company was hit by the devaluation of the Egyptian pound and an increasingly tough environment in the US where "competition is increasing and pricing pressure is intensifying," according to CEO Said Darwazah.
First-half revenue rose 1%, while operating profit fell 7% after a strong performance in Generics was offset by a weaker showing from Branded Generics. Strong operating cash flow helped the company reduce net debt from $697m to $633m, a perfectly healthy level considering the defensive nature of pharma companies.
Investors will surely be disappointed, but some cautiously optimistic comments regarding Hikma's Advair generic will go some way to soothing long-term fears. Sales of Advair, GlaxoSmithKline's (LSE: GSK) premier blockbuster drug, have held up better than expected since its patent expired back in 2016, because the Diskus delivery system it employs has been a tough one to crack for both Hikma and rivals Mylan and Novartis alike.
Hikma said it has managed to "clarify and resolve" a number of the FDA's questions regarding the key drug and reiterated there were "no material issues" concerning eventual approval. A more detailed update has been promised, but given the deterioration in the company's outlook, investors might not relax until more context has been given.
These delays are certainly to the benefit of Glaxo. Its massive 5.3% yield is barely covered by cash-flow and the extended no-competition period for Advair grants some much-needed breathing space so it can squeeze more out of its other businesses.
Right direction
I firmly believe that GSK is moving in the right direction and that a combination of margin expansion and slow-but-steady sales growth will eventually better cover the dividend. If this happens, it would not be surprising to see the shares re-rate to a more normal yield of around 4.5%, indicating a near 20% upside if the market gets comfortable with the payout.
The company's free cash flow jumped from £0.1bn in the first half of this year to £0.4bn, but if it is to achieve its target "to build free cash flow cover of the annual dividend to a target range of 1.25-1.50x," it must continue its run of form.
The rate of inevitable decline in Advair sales will be key for GSK over the next few years, as will performance in its HIV division which has really picked up the slack for the company of late. The firm did warn of "the impact of generic competition to Epzicom/Kivexa," so investors would do well to keep a close eye of the performance from the HIV treatments in future updates.
I find both companies attractive propositions at current prices. Hikma has had a terrible year, but its strong presence in North Africa and the Middle East should continue to drive growth as healthcare spend increases. Similarly, Glaxo might run into some short-term issues covering the dividend, but its pipeline looks bright and I'm cheered by new CEO Emma Wamlsley's strategic plan, specifically regarding a refocusing of capital allocation in the pharma business.
That said, I'd understand if readers were put off by the competitive pressures at both businesses. Those searching for safety may be better served seeking out similarly defensive companies that aren't experiencing immiediate pressures. Our analysts have found five companies with resilient payouts and tremendous track records that could help you glide to retirement. To read the investment theses behind these quality companies, click here.
Zach Coffell owns shares in GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Hikma Pharmaceuticals. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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