This Dividend Stock With a 4% Yield Is a Buy After Some Positive News

Unknown litigation costs have cast a cloud over wide-moat GSK since 2020, when the US Food and Drug Administration requested that Zantac be taken off the market. But earlier this month, GSK announced that it had agreed to pay as much as $2.2 billion to settle the majority of lawsuits in US state courts involving claims that Zantac caused cancer. We think this news removes a significant risk overhang for the company and should allow investors to focus more on GSK’s impressive product portfolio and pipeline potential instead of headlines. This dividend stock looks attractive, offering a 4% yield and trading well below our $54 fair value estimate. GSK lands on Morningstar’s Best Companies to Own list for 2024. It’s also one of Morningstar chief US market strategist Dave Sekera’s 5 Stocks to Buy if You’re Concerned About US Market Valuations.

As one of the largest pharmaceutical and vaccine companies, GSK has used its vast resources to create the next generation of healthcare treatments spanning several therapeutic classes. Its diverse portfolio insulates the company from problems with any single product. Additionally, GSK has developed next-generation drugs in respiratory and HIV that should help mitigate both branded and generic competition. We expect the company to be a major competitor in respiratory, HIV, and vaccines over the next decade. On the pipeline front, GSK has shifted from targeting slight enhancements toward true innovation. From a geographic standpoint, GSK is strategically branching out from developed markets into emerging markets. Its vaccine segment positions the firm well in these price-sensitive markets.

Key Morningstar Metrics for GSK

• Fair Value Estimate: $54
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium

Economic Moat Rating

Patents, economies of scale, and a powerful distribution network support a wide moat. GSK’s patent-protected drugs carry strong pricing power, enabling the firm to generate returns on invested capital in excess of its cost of capital. The patents also give the company time to develop the next generation of drugs before generic competition arises. GSK’s largest product, shingles vaccine Shingrix, does represent close to 10% of total sales, but we don’t expect heavy generic competition for it, given the complexities of vaccine manufacturing. GSK’s operating structure allows for cost-cutting following patent losses to reduce the margin pressure from lost high-margin drug sales. GSK’s established product line creates the enormous cash flows needed to fund the average $800 million in development costs per new drug. A powerful distribution network sets up the company as a strong partner for smaller drug companies that lack GSK’s resources.

Read more about GSK’s moat rating.

Fair Value Estimate for GSK Stock

We project cash flows in pounds and convert to dollars to obtain our fair value estimate of $54 per ADR. We forecast average annual sales growth of 4% over the next five years (including joint ventures), with newer products offsetting generic competition. Steady growth from vaccines should reduce the volatility from patent losses in the prescription drug business. We expect minor margin expansion over the next five years (excluding royalty income) as high-margin specialty drugs represent an increasing part of total sales. Increased scale in vaccines should further help these margins. In the later part of this decade, GSK does face patent losses on several key HIV drugs, which will likely create headwinds in 2028. We estimate GSK’s weighted average cost of capital at 7%, in line with the peer group.

Read more about GSK’s fair value estimate.

Risk and Uncertainty

GSK faces risks of drug delays or nonapprovals from regulatory agencies, increasingly aggressive generic rivals, and competition in the pharmaceutical industry. However, its high degree of diversification across platforms offsets the variable outcomes for drug development and competitive challenges to its leading products. We see access to basic services (tied to drug pricing) as the biggest environmental, social, and governance risk that the firm needs to manage. GSK generates close to one half of total sales from US vaccine and drug sales, so additional major pricing reforms could weigh on sales and margins. We think GSK’s product portfolio has average exposure to future potential litigation. We have factored in expenses for Zantac litigation.

Read more about GSK’s risk and uncertainty.

GSK Bulls Say

• GSK’s next-generation respiratory and HIV drugs look poised for strong near-term growth.
• GSK faces relatively minor near-term patent losses, setting up steady growth over the next three years.
• Well-positioned RSV vaccine Arexvy should support strong long-term growth based on excellent efficacy and limited competition.

GSK Bears Say

• HIV patent pressure on GSK’s key drugs is likely to begin in 2027, setting up a major hurdle for growth later in the decade.
• GSK’s late-stage pipeline is not strong. The company will need to develop its early-stage pipeline to support growth over the next decade.
• Arexvy could have a muted near-term sales ramp-up.

This article was compiled by Susan Dziubinski and Sylvia Hauser.