Share tip of the week: start your bargain-hunting with this pharma stock

published 21 November 2008

Maybe I'm just an optimist, but I believe there may be light at the end of the tunnel. In the last five bear markets, the Dow Jones fell an average 43% from peak to trough. In this slump, it's so far fallen 35%. Factor in the 25% drop in sterling and in dollar terms the FTSE 100 has lost 50%. This suggests we're nearing a floor. Best-of-breed stocks now trade at bargain prices and we could see more falls of up to, say, 20% due to panic-selling.

GlaxoSmithKline (LSE:GSK), rated a BUY by ABN Amro

Yet for the patient investor, I think now is a good time to dip back into the market. GlaxoSmithKline is one lower-risk opportunity. It is the world's fourth-largest drug maker by capitalisation at £65bn. Its top drugs include asthma medication Advair and antibiotic Augmentin. The firm supplies a quarter of the world's vaccines, protecting against illnesses such as diphtheria and typhoid. It also owns a huge consumer healthcare portfolio (15% of revenues) with global brands such as Gaviscon and Ribena.

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The City has fretted in the past about GlaxoSmithKline's exposure to patent expiries. But the group has been investing heavily (£3bn a year) to beef up its pipeline and now has several potential new blockbuster drugs. Around 20 major treatments are in Phase III trials, with 130 other promising early-stage compounds under review. This should offset sales lost to generic competition. The City expects 2008 sales and underlying earnings per share (EPS) to be £23.7bn and 101p respectively, rising to £24.1bn and 106p in 2009 with perhaps more profits to come after recent job cuts. The stock is on an undemanding 2008 p/e of 12, pays a 4.7% dividend yield and should benefit from the falling pound; more than 90% of revenues originate outsideBritain. The balance sheet is robust (net debt of £9bn) and it generates £6bn of operating cash flow each year.

So what are the dangers? There are constant threats from pipeline setbacks, government pricing pressures, generics, product concerns (such as its Avandia diabetes treatment) and potential litigation. But I think these risks have been overplayed. GlaxoSmithKline is well placed to benefit from ageing populations, greater consumption in emerging territories and rising vaccine demand. It's a classic defensive stock that looks too cheap for such a science-rich megacap.

Recommendation: GOODVALUE at £11.90

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.