GlaxoSmithKline (now known simply as GSK) has long been a favourite with dividend investors.

Despite that popularity, the sad reality is that GSK has long been a disappointment on almost every front, with its share price stuck in a sideways range for more than 20 years and its dividend remaining flat for the last eight years.

Unsurprisingly, shareholders have been pushing for radical change to break this cycle of stagnation and, in 2022, radical change is what they got.

GSK’s consumer healthcare business (perhaps the most attractive part of the company to dividend investors) has been spun off and the remaining business (sometimes referred to as New GSK) will now focus exclusively on vaccines and prescription medicines.

These are significant changes, so I thought this would be a good time to review this New GSK from a dividend investor’s perspective.

Table of contents

• A research-based pharmaceutical giant creating new vaccines and medicines
• Born from the merger of four leading healthcare companies
• GSK’s performance since 2009 has been underwhelming
• General medicines have been a serious drag on performance for years
• GSK’s strategy is focused on specialty medicines and vaccines
• Estimating GSK’s future revenues, earnings and dividends
• Estimating GSK’s fair value using a discounted dividend model
• Would I invest in GSK at the right price?

A research-based pharmaceutical giant creating new vaccines and medicines

I’ll begin with a review of GSK’s business model.

GSK is a research-based pharmaceutical company (also known as an innovator or originator drug company), which means it invents new drugs, brings them to market and sells them all over the world.

Each new drug has a lifecycle which involves a number of recurring steps:

Step 1: The drug development process begins with GSK spending years and sometimes decades researching and developing a potential new drug that it hopes will provide materially better patient outcomes than existing drugs. 

Step 2: If the drug is sufficiently promising in terms of effectiveness, safety and cost, GSK will try to obtain patents to give it the exclusive right to sell the drug for up to 20 years.

Step 3: Once patents are granted, the drug will be put through a series of clinical trials. In the first phase, the drug will be tested on a small number of people. If it proves sufficiently safe and effective, it will move onto the next phase where it will be tested on a larger number of people. If the drug proves to be effective and safe after three or more successively larger phases, the drug may be granted a licence by the regulator.

Step 4: Unlike most products, the price of patented drugs is often regulated, as is the case in the UK. In the UK, the price will be based on the increase in “quality-adjusted life years” provided by the new drug relative to existing drugs. GSK uses these calculations to make decisions about which areas of medical research it should fund, so that it doesn’t spend years researching a new drug that payers (governments, national health services, hospitals, doctors or patients) will be unwilling to buy.

Step 5: Having entered the market, the new drug will be sold exclusively by GSK for up to 20 years after the patents were granted. With limited competition, GSK will try to make enough profit from the drug to pay dividends to shareholders while also funding research into the next generation of vaccines and medicines.

Step 6: When the drug’s patents expire, it becomes a generic drug that any sufficiently capable generic manufacturer can produce. Generic drugs are pure commodities (paracetamol is paracetamol, whichever company makes it), so generic manufacturers are low-cost operators where low prices are all-important. GSK can’t compete with cheap generic drugs because it spends billions on ground-breaking research, so when a drug’s patents run out, GSK’s profits from that drug will usually collapse in a relatively short period of time.

Step 7: When GSK can no longer generate acceptable returns from the drug, it might licence the brand name to generic manufacturers, sell the brand name or simply stop production, at which point the drug’s lifecycle is effectively over as far as GSK is concerned.

Inventing ever-better vaccines and medicines is difficult and expensive, so GSK focuses its R&D efforts on a relatively small number of therapeutic areas where it may have competitive advantages. These are:

• Infectious diseases (including covid-19, meningitis, shingles, flu, polio)
• HIV (through GSK’s subsidiary, ViiV Healthcare)
• Oncology (mostly blood cancers, gynaecological cancers and solid tumours)
• Immunology (including asthma, lupus and rheumatoid arthritis)

Another way to segment healthcare is to think of it in terms of prevention and treatment, which translates into vaccines and medicines and that’s how GSK organises its three division.

Vaccines Division (30% of GSK’s revenue)

Vaccines help prevent infectious disease by boosting the patient’s immune response. GSK has the broadest portfolio of vaccines in the industry and about 70% of its vaccine sales relate to diseases most people are familiar with: shingles, diphtheria, tetanus, polio, meningitis and influenza.

In total, more than 2 million GSK vaccines are injected every day and four in ten people receive a GSK jab of one sort or another during childhood.

In terms of effectiveness, more than 90% of GSK’s portfolio has a vaccine efficacy of more than 90%, providing high levels of protection for patients. This also provides high levels of protection from competitors using newer technologies, such as mRNA vaccines, because those vaccines would offer little additional benefit to offset their higher costs. 

GSK also has the largest pipeline of potential new vaccines in the industry, with 16 candidates currently undergoing clinical trials, five of which are expected to launch by 2026.

Of course, covid-19 vaccines have generated a lot of attention over the last year or so, but GSK saw relatively little gain from the pandemic. In 2020, the pandemic was actually a headwind for GSK as lockdowns and other restrictions led to fewer non-covid vaccinations and prescriptions. In 2021, GSK’s pandemic-related sales came to £1.4 billion (about 6% of revenues) and in 2022, covid-related sales are expected to be not much more than £500 million.

Despite largely missing out on covid vaccine profits, GSK has launched other important vaccines in recent years, including Mosquirix, the world’s first malaria vaccine (malaria kills about 600,000 people every year).

Speciality Medicines Division (33% of revenue)

Specialty medicines are prescribed by specialists in hospitals rather than generalists such as GPs. They are either high-complexity, high-cost or high-touch (they’re often injectables rather than tablets) and they’re often used to treat complex, rare or life-threatening conditions such as cancer and HIV. Their cost and complexity make it harder for generic manufacturers to copy them after their patents run out, and this is good for GSK because it extends the period where GSK has little or no competition.

More than half of this division’s revenues come from ViiV Healthcare, one of the world’s leading HIV-focused pharmaceutical companies. HIV treatment and prevention is a significant market, with more than 38 million people living with HIV and around 1.7 million new infections each year.

General Medicines Division (37% of revenue)

General medicines are sometimes known as “white pills”, because that’s what most of them are, and they’re usually prescribed by non-specialists such as GPs. They’re less complex and easier to make than specialty medicines, so it’s much easier for generic manufacturers to copy them and general medicines are the bread and butter of most generic drug companies.

Born from the merger of four leading healthcare companies

GSK was previously known as GlaxoSmithKline and it was born in 2000 from the merger of Glaxo Wellcome and SmithKline Beecham. As those double-barrelled names suggest, Glaxo Wellcome and SmithKline Beecham were also created through mergers and acquisitions.