At first glance, there's not much difference between GlaxoSmithKline and AstraZeneca. Both are massive UK-listed drug companies. Both are popular with defensive investors.
But when it comes to their prospects well, it's not quite comparing night and day, but it's not far off. I've already discussed Astra's results this week. Here's why Glaxo looks by far the better bet.
If you didn't bother delving into the results, you might wonder what the grounds for optimism are. After all, Glaxo's fourth quarter sales were a bit lower than analysts had hoped.
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And while results for the year as a whole were solid enough, there's not much excitement there. Sales fell by 3% to £27.4bn, with operating profit down 5% to £8.6bn. This was largely down to the loss of income from anti-viral products and some pricing pressure.
The dividend rose by 7.7% to 70p per share. Shareholders will also receive an extra 5p dividend after the sale of some non-core brands.
Why Glaxo looks more resilient than Astra
Glaxo faces similar headwinds to Astra. Governments are looking to pay less for drugs while weak economies in Europe are a drag on growth. However, when you look at the scale of the impact on each business, you start to see why Glaxo is in a much better position than its rival. Last week, Astra estimated that these two effects cost its $3bn in lost sales in 2011. For GSK, it was just £315m.
But where Glaxo really scores is in the efficiency of its research and development. Put simply, it's streets ahead of Astra. Astra investors are wondering where the next blockbuster drug is coming from. Glaxo on the other hand expects to have around 30 new drugs in late stage development during the next three years. In 2012, it could file up to 10 new drugs for regulatory approval.
In other words, GSK looks very well placed to replace the income streams of drugs that lose patent protection. In contrast, Astra's profits are falling off a cliff.
What's especially heartening for GSK shareholders is the returns on the company's R&D spend. GSK estimates it will earn 12% on its R&D investment and is confident that it can increase this to 14%. These represent steady rather than stellar returns, but should be sufficient to keep profits growing.
Astra spent £3.4bn on R&D last year ($5.5bn) compared with £3.9bn at GSK. We don't know what Astra's returns are - but they are clearly a lot lower.
GSK lower risk, higher returns?
It is not all plain sailing for Glaxo. It will eventually face some competition for its biggest-selling drug, asthma treatment Advair. It hopes that Relovair will prove to be a good replacement but it's too early to tell. What seems more likely though is that Glaxo will be able to keep growing its profits and dividends for a while yet.
Contrast this with AstraZeneca's falling profits. It plans to buy-back another $4.5bn of its own shares this year in order to support its dividend payments. In the short-term, buying back its own shares actually enhances Astra's cash flow. This is because it saves paying the big dividend yield on the shares bought back (currently 6.4%) by using its cash balances that currently pay little or no interest or cheap debt. (This begs the question why more companies with high dividend yields aren't doing this). Further out, Astra needs new sources of income or else its dividend looks unsustainable.
So should you buy shares in Glaxo? At 1,396p, the shares trade on 11 times consensus 2012 earnings and offer a dividend yield of 5.2%. With profits expected to keep growing and the possibility of more bonus dividends, the shares look reasonable value. Put another way, you will probably sleep sounder owning Glaxo shares than owning shares in Astra.
