GlaxoSmithKline: The Fate of Avandia?

07/22/2013 6:00 am EST


John Dessauer

President, John Dessauer Investments, Inc.

It doesn't happen often, but once in a while the FDA changes its collective mind; in this case, the drug involved is Avandia, from GlaxoSmithKline, used to treat type 2 diabetes, says John Dessauer, editor of John Dessauer's Outlook.

In 2009, 2.7 million people used Avandia and the drug was a billion dollar, blockbuster revenue source for GlaxoSmithKline (GSK). But a study found a risk of heart problems and the FDA issued restrictions on the use of Avandia. After the restrictions took effect, the number of patients using the drug collapsed.

Glaxo's research disagreed. A six year study of 4,447 type 2 diabetes patients showed no increased risk of heart disease. In response to the FDA, Glaxo asked scientists at Duke University to review their research. They did, and found it to be correct.

Glaxo went back to the FDA and a panel there recently ruled in favor of Glaxo. Of the 26 panel members, 13 voted to ease the restrictions, seven wanted the curbs removed entirely, five wanted the restrictions left in place and one wanted the drug to be entirely removed from the US market.

The majority rules, so the Avandia case is back on the FDA's agenda. Avandia could be back, unrestricted, on the market soon. Even if the number of patient users rises to only a million or so, Avandia will, once again, be a major revenue source for Glaxo.

There is more to like about Glaxo. For example, the company has spent more than 2 billion pounds buying back shares in each of the last two years. Management plans to buy back another 1 to 2 billion pounds worth of shares this year.

The sale of its proprietary drinks business could provide $2.5 billion more in cash that could be used for share buybacks. Then there is the attractive dividend, currently providing a yield of 4.3%.

As if all this is not enough to make the stock attractive there is a drug called Breo Ellipta, a new respiratory treatment, that has blockbuster potential. And Glaxo's pipeline has another half dozen new drugs in phase 3 trials.

The risk in Glaxo is reduced by its diversification. Glaxo gets 25% of its revenue from over the counter healthcare products. There is also geographic diversification. 33% of revenue comes from the US 21% from Europe, 8% from Japan, and 20% from emerging markets.

In 2007, Glaxo's stock traded at $60. A return to $60 would be a 14% capital gain, plus the annual dividend for an 18% total return-not bad in this low interest rate environment.

Glaxo is a buy, but with a word of caution. Even though the Glaxo story is compelling, there are doubters. The stock could pull back at any time before moving to the $60 level. A pullback to $50 or lower would be a compelling entry point.

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