Chapter 1 Introduction

1.1 History and Background of the Study

            Glaxo Smith Kline (GSK) is a health care pharmaceutical company being formed in 2001 with the collaboration and merger of Glaxo Wellcome Public Limited Company (PLC) and SmithKline Beecham PLC. The principal activities of GSK are to deal with health care medicines, vaccines, researching and nutrition products for its customers (Prange & Kattenbach, 2019). According to GSK (2020) annual report describes that the company’s main focus on immune system, enlarging Research and Development (R&D) base and genetics issues within the domain of the pharma.

1.2 Motivation of the Study for GSK

            GSK has attained the world rank # 146 as of January 1st, 2021 and distributes its products around 150 countries and labor force is more than 100,000 around the whole globe.  The company expands its business year after year and focusing more on life saving drugs, such as, Human Immunodeficiency Virus (HIV), oncology and advanced innovative technologies (GSK, 2020).

            GSK is a MultiNational Company (MNC); and the revenue results, Profitability, growth rate, Earning Per Share (EPS), dividend payout and expansion in the field of pharma not only restricts to United Kingdom (UK) but flourishing throughout the whole world and GSK is the symbol of trust for patients and investors who invest their investments in GSK pharma. Motivation of GSK is that share price shoots up in every stock market whether London Stock Exchange (LSE) or New York Stock Exchange (NYSE) or anywhere in the world. The valuation of Assets, Liabilities and Equities are also significant as per the balance sheet of GSK of the last 5 years. The performance of GSK can be stated under the following tables:

Year Ending

Revenue

Operating Income

Net Profit after Tax

EPS (GBP) in Pence

Dec20

34,099

7,783

6,388

115.5

Dec19

33,754

6,961

5,268

93.9

Dec18

30,821

5,483

4,046

73.7

Dec17

30,186

4,087

2,169

31.4

Dec16

27,889

2,598

1,062

18.8

Tabel 1 is a summary of showing the growth of GSK in terms of turnover, profitability before tax and after tax and EPS from the period of 20162020 motivates me to invest in this pharma. In addition, table 2 presents the same story but geographical dispersion of GSK brand.

Table 2: GSK Turnover geographically from 20162020

Group turnover by geographic region

2020 £m

2019 £m

2018 £m

2017 £m

2016 £m

US

14,556

13,890

11,982

11,263

10,197

Europe

8,164

8,069

7,973

7,943

7,476

International

11,379

11,795

10,866

10,980

10,216

Total

34099

33,754

30,821

30,186

27,889

 

1.3 Past Performance of GSK Pharma at a Glance

            It can be better understood by the following pin points:

  1. Growth in turnover has been increased from the past five years as shown in the above table; higher sales revenue leads to higher profitability and it seems to pay higher amount of dividend to GSK shareholders.
  2. GSK pays attention towards R&D cost. It increases to £5,098 million in 2020 from £4568 million in 2019 showing the growth rate of 12% (GSK, 2020). Without enlarging the R&D cost base, the pharmaceutical companies will be unable to perform in the long run because of patents amortization, innovation and upgrading the technologies, etc. (Paul, Mytelka, Dunwiddie, Persinger, Munos, Lindborg, & Schacht, 2010; Rizhamadze, 2020).
  3. Dividend pay out to the shareholders are also increasing year after year so it is a positive sign to make the portfolio for the GSK share. Investors are very keen to know what should be the dividend yield and capital gain either on the short and long run. The crux of GSK dividend is shown below:

Share Price of GSK in LSE

2020

2019

2018

 

 £

 £

 £

At 1 January

17.79

14.91

13.23

At 31 December

13.42

17.79

14.91

Increase/(decrease)

24.60%

19.30%

12.70%

High during the year

18.46

18.19

16.22

Low during the year

12.92

14.36

12.43

1.4 Inclusion and Exclusion Criteria for GSK in the Portfolio

            Since, GSK deals in Pharma products so for the investor, it is very important to know the share price of GSK in LSE and how volatility is there in this stock. As      portfolio is based on the movement of the share price, market beta, pharma beta and GSK beta if it indicates that abrupt volatility is there with the share price of GSK, then it is better to keep away from the market. However, it is already mentioned in the above paragraph that (24.6%) reduction has been taken place in the share price of GSK in the year of 2020. So, it indicates that to reduce the portfolio of GSK pharma in the current year or it can be held for short term purpose for getting the capital gain.

            Apart from this, inclusion and exclusion criteria should be judged on the basis of market sentiment and GSK fundamentals. Though, it is a clear evidence that GSK enhances its pharma products base in health care medicines, viruses, respiratory, HIV, oncology and so on. Being a financial analyst, I will check the future outlook of the company, growth rate, dividend yield, EPSbasic and diluted, returns on equity, net profit rate after tax, debt to equity ratio, principal activities of the business, expansion of the market and many more. These stated points will determine the inclusion and exclusion of GSK in the investing company’s portfolio.

Chapter 2 Cost of Equity for GSK

            Cost of equity is a cardinal factor for finance subject as the investors always make the decisions for making portfolios in the stock market in terms of any sector, for example, pharmaceutical sector, evaluates and analyzes the cost of equity (Faysal, Salehi & Moradi, 2020). However, the Chief Executive Officer (CEO) has given me the task to identify what should be the cost of equity for GSKPharma.

            There are two approaches to calculate the cost of equity, i.e., dividend growth model and Capital Asset Pricing Model (CAPM). However, the researcher selects CAPM model because it is more realistic than Gordon Growth Model (GGM).

2.1 Risk Free Rate:

            GSK locates in UK so assuming the majority of the investors also live in UK. Risk free rate is provided by Bank of England known as State bank of UK. This rate is applied on treasury bills where the investors risk is almost zero percent because it is supported by UK government. Hence, making the portfolio on treasury bills depend the company’s intention to be “risk averter”. Assuming the current riskfree rate on treasury bills is 0.9058%.

2.2 Market Premium:

            Market premium is also known as risk premium, if our company invests in GSKPharma as compared to Treasury bills. Generally, we assume that the market return is relatively higher than Tbill’s rate. Assuming the expected return of the stock market is 6.9058%. Hence, risk premium is the difference between expected return and riskfree rate. It can be presented under the following table:

Table 5:

Risk premium for GSK Pharma in %

Expected Returns

6.0958

Less: Risk free Rate

0.0958

Risk premium

6

                                                            (Source: Author’s work)

2.3 Beta Coefficient for GSKPharma:

            Beta coefficient is an important element that indicates about the particular company’s movement with regard to market index. Assuming the GSK beta is 0.8 in LSE market.

2.3 Calculation for Cost of Equity for GSKPharma:

            We are assuming the cost of equity for 2021 investment on GSKPharma and the expected return should be there while making investment on this company at the financial year end.  The formula for cost of equity is as under:

 Ke = Rf + B (Rm – RF)

 

Where

Ke= Cost of equity

Rf= Risk free rate on treasury bills                 = 0.9058%

B= beta for GSKPharma                               = 0.8

Rm= Expected Return on stock market         =6.9058

Thus, Ke= 0.9058%+ 0.8 (6.9058% 0.9058%)

  Ke = 5.7058% = Cost of Equity for GSKpharma

Chapter 3 Cost of Debt

Thu, Khanh, Ha, and Khuong (2018) defines the cost of debt means any borrowing cost which the company has to pay to its lenders on the specified period normally yearly.  With regard to GSK Pharma cost of debt can be calculated later on; but firstly, showing the net debt as per the published report of GSK (2020). The following table shows the net debt of GSK in 2020 and 2019 respectively.

Formula for cost of debt calculation:

Finance expense*100  =     £892*100             = 1.11% Rate of borrowing cost

Net debt                             £ 20780   

 

            The cost of debt is 1.11% in the year of 2020 which shows the company’s borrowing rate is under control. The cost of debt really attracts the shareholders especially for potential shareholders who are keen to invest in GSKPharma. If the borrowing cost is very high then profit which is attributable to shareholders is very minimal and they face the problem regarding their investment in GSKPharma.

Chapter 4Cash Flow Statement

            Cash flow statement shows the liquidity and solvency of the company like GSKPharma. There are two different approaches being used to present cash flow statement, such as, Direct method and Indirect Method. However, the published company’s accounts show the indirect method because it starts from profit before interest and corporate tax (Jaafar, Hassan & Ismail, 2021; Soni & Dubey, 2021).

            Cash flow contains three activities like cash generated from operations, investing activities and financing activities.  In short, cash flow statement shows the surplus or deficit balance of a particular company in this case GSKPharma.

4.1 Cash Flow Statement for Equity Assumption

            Under both of the approaches direct and indirect method, the way of presentation is the same but under International Accounting Standards (IASs) # 07 that indicates about how to deal with cash flow statement under equity section. Hence, there two alternatives are available like the payment of cash dividend either it should be subtracted from the operating activities or form the financing activities. so, these two alternatives are given and that depends upon the company’s accounting policies and strategies which they normally apply on the ordinary course of business. Both of these approaches are permissible under IAS7 which shows the treatment of cash flow statement especially for dividend payout.

                        Chapter 5 Growth rate of GSK Pharma

            Calculating the growth rate is very easy as we calculate the growth rate from the prior year and compare with current year. GSKPharma compares the growth rate in many aspects including research and development cost, sales turnover growth rate, dividend payment, health care products, etc. The growth rate of GSKPharma compares its growth rate with PfizerPharma in the annual accounts of 2020. The table shows the comparison of both the companies in terms of key findings are as follows:                    

            In the above table indicates Constant Exchange Rate (CER) which is the critical success factor for the growth for a particular company. In addition, GSKPharma pays attention towards its growth rate in every field as the comparison show the company stance presently and GSK Pharma identifies the room for growth in the pharma sector and increase the wealth of the assets for the shareholders through jump in share prices of GSKPharma in LSE.

Chapter 6: Terminal Value for GSKPharma in 2020

            Terminal value is a significant element for the company’s performance and it is used as symbol of future forecast for the cash flow. This value can be calculated by making the difference between discounting factor and terminal growth rate in the stated period (Siddiqui, & Patil, 2017). In addition, there are several researchers who define terminal value is that value which can be estimated for the longerterm period even beyond the circle of a company. The important element for this theory that the business will grow in the foreseeable future without any bottleneck.

            GSKPharma maintains the projected cash flows for the upcoming five years plans and the below table indicates the progress of the stated company in the year of 2020. Terminal value can assist the future outflow in terms of discount factor and growth rate of GSKPharma. The summary of the table is as under:

Chapter 7 GSK Value through National and International Peers

            GSKPharma competes for its rival firms mainly Pfizer and Abbott Laboratories for several years. To maintain the prestige of the company is not an easy task and it requires several corrective and remedial actions. The following table which gives the clear cut example for its peers with local and international markets which can be precisely shown in the following table.

            If we look at market capitalization of GSKPharma then it is relatively lower than its counter parts rival firm but even then, it enhances its product base in several fields. Furthermore, the company attains the credibility in terms of the patient satisfaction and health care centers. Thus, there is also a chance that the company achieves the required target for its expansion of the business and growth as a constant level at any cost. Lastly, the company has the object to maximize the shareholders wealth within a given time span.

Chapter 8 Advantages and Disadvantages of different Approaches for GSKPharma

8.1 Advantages of Valuation Process for GSKPharma

             The results are evaluated and interpreted on the basis of published final accounts of GSKPharma in the year of 2020. Most of the results are applied on the historical cost accounting practices and adopted policies of the company. For investment purpose, GSKPharma has a lot of potential by means of dividend pay out ratio, EPS, borrowing rate, R&D cost, sales growth, net profit rate, share price in LSE market, enhancing the health care products, expansion of the business locally and internationally.

            The researcher applies several assumptions for GSKPharma by using different techniques, such as, cost of equity ratio, debt ratio, cash flow statement for checking the liquidity position, terminal value of its assets, growth rate, comparison of GSKPharma with its rival firms and many more. Thus, these are the points which will give a good comparison to make a portfolio for inclusion and exclusion of GSKPharma in the investment.

8.2 Disadvantages of Valuation Process for GSKPharma

            There are several cons are also there with GSKPharma such as low market capitalization in the equity base, reduction in share price in the current year, i.e., 24.6%., high operating cost, jump in the R&D cost current year if we compare with Pfizer. Terminal value restricts to 5 years, reduction in the dividend per share and not having access to international market as it should be, high beta rate. Hence, the company has to take the remedial actions to overcome the deficiencies. Otherwise, the drastic will come out and lose the confidence of the shareholders who invest their money on GSKPharma.

References

Faysal, S., Salehi, M. and Moradi, M., 2020. The impact of ownership structure on the cost of equity in emerging markets. Management Research Review.

Jaafar, S.B., Hassan, H. and Ismail, S., 2021. Cash flow statement as a tool to predict financial distress. Available at SSRN 3838158.

Paul, S.M., Mytelka, D.S., Dunwiddie, C.T., Persinger, C.C., Munos, B.H., Lindborg, S.R. and Schacht, A.L., 2010. How to improve R&D productivity: the pharmaceutical industrys grand challenge. Nature reviews Drug discovery9(3), pp.203214.

Prange, C. and Kattenbach, R. eds., 2019. Management practices in Asia: case studies on market entry, CSR, and coaching. Springer Nature.

Rizhamadze, K., 2020. Analyzing Business Model, Narrative and Numbers of GSK (Glaxosmithkline). Eurasian Journal of Social Sciences8(1), pp.3541.

Siddiqui, S.S. and Patil, V.A., 2017, June. Proposed system for estimating intrinsic value of stock using Monte Carlo simulation. In 2017 International Conference on Intelligent Computing and Control Systems (ICICCS) (pp. 723729). IEEE.

Soni, C.M. and Dubey, C.V., 2021. A Study of Various Aspects of Cash Flow Statement of Pharmaceutical Companies in India. PalArchs Journal of Archaeology of Egypt/Egyptology18(4), pp.77707779.

Thu, P.A., Khanh, T.H.T., Ha, N.T.T. and Khuong, N.V., 2018. Perceived audit quality, earnings management and cost of debt capital: Evidence from the energy listed firms on vietnam’s stock market. International Journal of Energy Economics and Policy8(6), pp.120127.

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