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Uncertain prognosis at Glaxo

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It has been a strong week for equities, as a batch of well received corporate earnings outweighed fresh concerns over the outlook for the global economy. 

Risk assets reacted favourably to Italian news that Giorgio Napolitano, head of state, was elected for a second term, prompting hopes of an end to the political gridlock in Rome. The re-election is a positive for Italy and will pave the way for a coalition government, sending bond yields sharply lower.

The prospect of continued central bank liquidity in Japan also helped support the market. The G20 waved through the country’s attempts to stimulate its economy, pushing the Nikkei 225 to its highest close in nearly five years. 

Better data from Europe, including the UK avoiding a triple-dip recession, was overshadowed by further disappointing news from Germany. Markit’s flash Eurozone services PMI, an early gauge of business activity each month, rose to 46.6 in April from 46.4 in March, despite a surprise decline from German companies that form the backbone of the Eurozone economy. 

German private sector output in April contracted for the first time in five months and business sentiment fell for a second consecutive month, missing even the lowest estimate, heightening the likelihood of a prolonged recession in Europe. The weakness, however, rekindled talk of an interest rate cut from the European Central Bank, boosting equities, but sending the Euro lower against a basket of other currencies.

Purchasing managers’ indices from China and the US also came in weaker than expected, with the HSBC-Markit flash manufacturing PMI falling to 50.5 from 51.6 in March. A sub-index highlighted a large fall in export orders, reflecting weak global demand as the US recovery remains fragile and the Eurozone is mired in recession. 

Meanwhile, the US flash manufacturing PMI revealed the weakest reading in six months, dropping to 52.0 from 54.6 in March. Durable goods orders also tumbled 5.7% last month, worse than the market had expected, suggesting the first quarter GDP data due on Friday could come in below expectations. 

Industrial commodities staged a modest recovery, with Brent crude rising back above $100 a barrel after falling to as low as $96.75 last week. Gold also continued to recover after tumbling to its lowest level in two years, rising to $1455 an ounce.

Technical analysis illustrates the recent recovery, with the FTSE 100 breaking out of the recent trading range to a fresh short-term high. The oscillators are trending higher from an oversold position, with the MACD stepping into positive territory, indicating an increase in momentum, with higher trading volumes evident on the recent up days. Support is now seen at 6395 and 6245, with a move above 6535 needed to confirm the longer term upward trend remains intact.

In conclusion, equities remained surprisingly resilient, despite a bout of disappointing macro-economic data, offset by expectations that the Federal Reserve would maintain its accommodative policy stance and strong corporate earnings. Therefore, for the time being the market is likely to remain choppy, as sentiment swings from the prospect of a stimulus driven recovery to that of concern over the global recovery.

The pharmaceutical companies have been among the top performers this year, amid hopes the sector is poised to return to growth after years of slumping sales caused by the loss of patent protection for key drugs.

Market leader GlaxoSmithKline (Epic: GSK) has gained over 30% this year, despite this week reporting a 12% slide in core pre-tax profit to £1.8 billion in the first three months of the year and a 3% fall in sales to £6.5 billion. 

Glaxo is counting on regulatory decisions on six drugs as it seeks to boost sales by 1% this year and earnings per share by 3% to 4%. The company has filed for US approval of the lung drugs Anoro and Breo, Dolutegravir for HIV, Dabrafenib and Trametinib for skin cancer and Albiglutide for type 2 diabetes.

Having completed a review of its Lucozade and Ribena drinks brands, Glaxo has decided to dispose of them. The brands don’t fit with either the company’s health care products or its emerging markets business and the sales could raise between £1 billion and £1.5 billion, which could enable more share buyback. The drugs giant is already targeting buybacks of between £1 billion to £2 billion this year. 

 

 

The above chart of Glaxo illustrates the acute rise experienced this year, with the shares trading at levels last seen in 2002. It is, however, worth noting that the oscillators are trading at their most overbought level in the past ten years, suggesting that momentum could be near exhaustion and a retracement growing more likely.

Glaxo now trades on a weighty 14.6x earnings, which is in line with industry dynamos Novartis and Roche, both of which boast higher profits and growth forecasts. In comparison, Novartis, reported first quarter sales growth of 2%, with products launched since 2008 accounting for 36% of revenue. At Glaxo, new products launched since 2008 contribute just 6% of sales. 

In conclusion, I don’t believe Glaxo’s diagnosis is yet stable. Growth remains lacklustre, leaving them looking expensive compared to industry peers, while the overbought technicals and only a 4.6% dividend yield to new shareholders, means the shares look fully valued at current prices.

At the time of writing the share price is 1682p and traders might consider a short-trade, with targets seen at 1615p, 1544p and 1487p, while a stop-loss above the recent high at 1732p could limit the risk.

 

This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in GlaxoSmithKline, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and GlaxoSmithKline’ s corporate website.

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