This week GSK Nigeria (GLAXOSMI) announced that its profits through the first nine months of 2014 dropped 23% compared to the same time period last year.
The news came as a bitter pill to investors. The stock has fallen nearly 16% over the past thirty days and now trades at its lowest price in 16 months.
Are the shares bad medicine? Just what the doctor ordered? Or something in between?
Let’s have a closer look at the numbers and see what they reveal.
GSK Nigeria: More Than Just Drugs
GlaxoSmithKline Consumer Nigeria markets and manufactures a wide range of pharmaceuticals and vaccines. Its line-up of wares includes everything from acetaminophen to cancer drugs, many of which it produces at a factory just west of Lagos. Most are distributed in Nigeria, but it has recently begun to export to Ghana, too.
Perhaps surprisingly, however, GSK Nigeria’s best-selling products are beverages – not medicines. In 2013, sales of Lucozade (an energy drink) and Ribena (a fruit concentrate beverage) accounted for over half of the company’s revenue and operating profit.
The Big Margin Squeeze
The heavy dependence on these two brands helps explain GSK Nigeria’s lackluster performance of late.
Alarmed at the prospect of losing its most lucrative products, GSK Nigeria’s management scrambled to negotiate a deal with Suntory which would allow it to continue to manufacture and distribute the drinks in West Africa. They worked out an agreement, but the terms included a licensing fee that dented GSK Nigeria’s profit margins.
The company’s first half results clearly show the deal’s impact on profitability. Licensing fees squeezed the gross margin from 14.6% in the first six months of 2013 to 7.5% a year later. With such a sharp spike in the cost of sales, it’s little wonder that the bottom line has slipped.
On the Mend?
But here’s the good news for GSK Nigeria shareholders. Management is doing an excellent job of containing costs apart from the new licensing fees. Administration costs have been slashed nearly 15%, and ongoing upgrades at its Agbara factory look to widen the product offering and improve efficiency.
The impact of this can be seen in the most recent results. Earnings in the third quarter of 2014 actually grew 22.5% compared to the same period last year.
How Nice is the Price?
GSK Nigeria currently trades at price equivalent to 4.2x its net asset value and at a dividend yield of 2.53%.
Over the past twelve months, the company’s book value increased 10.9%, considerably slower than its annualized rate of 14.6% over the past five years. Since 2009, the stock’s price/book ratio has ranged from a high of 5.8 to a low of 1.8.
Let’s assume that the company grows net asset value at a rate of 10.9% over the next five years and that management raises the dividend at a similar pace. Let’s further assume that the market values the stock at 3.8x book value five years hence – the midpoint of its range over the past five years.
Under these assumptions, the company’s share price five years from now would rise to NGN83.85 from its current level of NGN54.00. If we add five years of dividends to that price, investors would reap an annualized return of 11.4%.
That’s not a great return considering that the yield on a 10-year Nigerian government bond now hovers around 12.6%.
But if management can find a way to compensate for the reduced profitability of Lucozade and Ribena and grow book value at its 5-year average of 14.6%, then investors can expect a juicier annualized return of 15.0%.
As for me, I’m staying on the sidelines for the time being, but if the stock’s price drops further on no substantive news, I may be enticed to pick up a few shares.
What Do You Think?
Do shares of GSK Nigeria look like a good buy here? Tell us why you do (or don’t) like the stock in the comments!
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