Glaxo's Avandia Issue Priced-In

We highlight GlaxoSmithKline plc (GSK - Analyst Report).

GlaxoSmithKline - Maintaining Hold Recommendation

Sales of Avandia have been significantly negatively impacted due to safety concerns, but it appears they have recently stabilized. We believe that sales are now at, or very near, their bottom. While sales of Avandia have been cut in half from their peak level reached in 2006, it remains a very important product to GlaxoSmithKline plc (GSK - Analyst Report), and stabilizing sales would be very good news.

Other than the Avandia issue, Glaxo still has to deal with generic erosion of a number of drugs, including Coreg IR, Flonase, Wellbutrin XR, Lamictal, Requip, Valtrex and Imitrex. On the positive front, we continue to be impressed by the vaccine franchise and look forward to the contribution from Rotarix, Promacta and Synflorix. And although we were disappointed by the recent delay with Cervarix, we remain confident that it will eventually be a big growth driver for the vaccine business. Advair sales should see some incremental revenue growth from the recent launch in Japan.

We like what we see in the form of quality and quantity of products in the pipeline and were encouraged to see a number of key approvals during 2008. Glaxo has demonstrated its determination in getting drugs to market which has been recently highlighted by the long-awaited FDA approvals of Treximet and Tykerb. Also, after a short delay, Promacta received approval in November 2008.

The Consumer side of the business is performing very well, and we like what we see from management in terms of growing the top-line through the addition of core products such as Alli. On the Operational side of the business, Glaxo recently announced a new Operational Excellence program. Initially designed to save £700 million per year, it has now been expanded to wring out an additional £1 billion by 2011. This should provide a significant offset to increasing generic competition in the next few years and help earnings grow faster than revenues.

We also believe that Glaxo remains interested in accelerating growth through acquisitions, and think the recent drop in equity prices has created potential opportunities to do so. Management made it clear on the fourth quarter call that while they will be looking for strategic acquisitions, they are not interested in doing a large deal. Significant share repurchases will continue to be suspended in order to increase capital levels in the event that attractive acquisition opportunities do arise.

Glaxo's financial performance significantly benefited from the British Pound weakening against other currencies, most notably the U.S. dollar, during 2008. Our forecast for 2009 assumes Glaxo continues to substantially benefit from foreign exchange, although not to the degree as in the fourth quarter or full-year of 2008.

In 2009 we expect generic erosion to several products to be more than offset by positive growth in key products such as vaccines and Advair sales as well as the benefit from foreign exchange. The result should be 2009 sales growth of about 6%. EPS should continue to benefit from the productivity initiative, partially offset by narrowing gross margins due to increased generic competition during the year.

Glaxo's hard push in getting late-stage products to market should also incrementally increase R&D expense. The net result should be EPS growth of 11% in 2009.

While the company is faced with a number of challenges, we continue to like the fundamentals at Glaxo. We believe the company offers one of the stronger late-stage pipelines in big pharma, and with the Avandia issue already baked into the stock price, the shares are currently fairly valued.

The $1.98 per share dividend currently yields 6.57%. We recommend holding the shares and have a target price of $34, representing 9.9x our $3.43 (£1.164) 2009 EPS estimate.

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