Share tip: buy Glaxo for its drug pipeline

Investors in the drugs giant GlaxoSmithKline (GSK) would be forgiven for feeling a little hard done by. While AstraZeneca has been courted by acquisitive American suitor Pfizer, sending shares soaring by more than 20pc during the past six months, GSK has attracted all the wrong sort of attention. The company is now under investigation by the UK Serious Fraud Office (SFO) after Chinese authorities threw the book at the company in July last year, alleging widespread bribing of medical practitioners. Bribery allegations have followed in Jordan, Lebanon, Poland and Iraq.

The biggest concern is just how damaging all this could be for GSK. China, where the problems all began, is still less than 4pc of group revenue. The fine, if it is decided some rogue employees have indeed been lining doctors’ pockets with cash, would be manageable.

The bigger problem would be if the bribery overseas was found to be widespread and worst of all if people at the top knew about it. If that was the case authorities in the UK and US would get involved, read material fines and barring from supplying governments; bad medicine indeed.

Jobs and Desperate needs

There are some mitigating factors that work in GSK’s favour. The US and UK have double jeopardy rules, so GSK cannot be fined for the same offence twice. Western governments also desperately need the new drugs that GSK is developing and a heavy fine could seriously delay their release. Fines would also ultimately lead to job losses and possibly put pressure on the dividend. At the moment the company is forecast to generate more than £5bn in free cash flow this year, which more than covers the £4.1bn in prospective dividend payments that offer a yield of 5.2pc.

Drug development

Glaxo has an exciting drug development pipeline that will provide new revenue if successful. The company has 13 drugs in the final stage of testing, the results of which are expected during the coming 12 months. There was disappointment when the company stopped a late-stage trial of its cancer vaccine MAGE-A3 after disappointing results. However, the rest of the pipeline is intact. The shares are now trading on 15.6 times forecast earnings, falling to 14 times next year. Questor isn’t blind to the risks here but the fundamentals remain. Buy

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