Investors’ Chronicle: Lloyds Banking Group, Reach, GSK

BUY: GSK (GSK)

Sceptics will say the pipeline leaves much to be desired, but there’s no denying the drugmaker’s present strengths, writes Jennifer Johnson.

Recent sales progress at GSK has largely been driven by two things: the Shingrix shingles vaccine and its HIV franchise. The drugmaker’s half-year results confirm that this is still the case — and momentum has been so strong that management has upped its full-year earnings forecasts. 

Turnover is now expected to increase somewhere between 8 and 10 per cent, up from the previously stated 6 to 8 per cent. Meanwhile, adjusted operating profit is predicted to rise by 11 to 13 per cent (instead of 10 to 12 per cent). However, this may not fully allay lingering concerns that the group’s portfolio is too concentrated in a handful of therapeutic areas.

The so-called “patent cliff” — the point at which a drug loses exclusive marketing rights and generics become available — is a major problem for most pharmaceutical companies. However, they can minimise the hit to earnings by continuing to develop new drugs across a broad range of disease categories. 

Analysts have long been concerned about GSK’s patent cliff exposure and the size of its pipeline. This is something that chief executive Emma Walmsley has made efforts to address. In the past quarter, the company’s RSV vaccine for older adults was approved by regulators in the US and EU and it completed the acquisition of Bellus Health, a Canadian biotech with a near-to-market treatment for chronic cough.

However, it is likely to take GSK a bit longer to build a comfortably-stocked pipeline. It has only been a year since it sold off its consumer healthcare business, now trading as Haleon, in an effort to focus more on vaccines and prescription medications. The company’s valuation, which is still under 10 times projected earnings for the full year, arguably reflects this uncertain outlook.

It also speaks to continuing market jitters about the potential impact of the ongoing Zantac litigation in the US. Manufacturers stopped selling the heartburn drug four years ago over concerns that it contained harmful levels of a probable carcinogen called NDMA. But a Florida judge threw out thousands of claims last December, and GSK settled out of court with another plaintiff in California last month.

The shares rebounded in both instances — although they’re still down 20 per cent over the past year. With the next bellwether trial scheduled for November, some investors might be hesitant. At its current bargain price, we’d argue GSK appears worth the risk.

HOLD: Lloyds Banking Group (LLOY)

Lloyds’ correlation to the UK economy proves a mixed blessing at a time of higher profits, but also rising bad debts, writes Julian Hofmann.

On the face of it, half-year results for Lloyds Banking Group showed the benefit of widening interest rate margins, with the “black horse” closing in on half-year profits of £3.9bn, substantially up on the £3.1bn it generated at this point last year, thanks to the Bank of England’s interest rate raising campaign.

However, the market’s reaction was decidedly muted after the results showed another large charge for bad loans of £700mn, compared with the £465mn the bank set aside at the full-year results, along with management’s warning that the outlook remains “uncertain”.

The net result was that Lloyds’ performance came in slightly below the City’s forecasts, with the downbeat mood overshadowing management raising its margin guidance forecast for the year.

The widening spread between the loan rates that Lloyds’ charges its borrowers versus the interest it pays its depositors meant that the net interest margin for the year full year is now expected to be 3.1 per cent, compared with the 3.05 per cent the bank had previously expected. That had a positive impact on the key return on tangible equity which came in at a respectable 16 per cent.

It is really the rising levels of bad debt, while bearable in the context of Lloyds’ £400bn loan book, that indicate that large numbers of its customers — around 35 per cent of loan holders — are experiencing greatly increased costs. Management also assesses that these credit conditions will persist through the year.

This was already apparent in Lloyds’ shrinking loan book, which fell by £4.2bn to £451bn, along with a churn in customer deposits of 1.2 per cent to leave deposits lower at £470bn — although the loan/deposit ratio was essentially flat at 96 per cent. This could be the first indication that customers are starting to chase higher interest rate deals, although the picture will be clearer as the year progresses.

Overall, the results were acceptable, although even the normally positive analyst take from Jefferies could not see consensus forecasts for the year shifting on the back of these results.

The correlation between Lloyds and the fortunes of the broader housing market were evident in rising bad debts. With the shares hitting a consensus price/earnings forecast of no more than six times forward earnings, the debate is not whether they are expensive but simply unable to break out of a tight trading range for an institution that has utility-like characteristics.

SELL: Reach (RCH)

The publisher has blamed Facebook for a decline in digital page views, writes Jemma Slingo.

Shares in the UK’s biggest commercial news publisher Reach jumped by almost 20 per cent in the wake of its full-year results. Investors were reassured that full-year profits would likely be in line with expectations, and pleased that print circulation revenue had grown. 

There was plenty for shareholders to worry about in the interim figures, however. Digital sales, for instance, fell by 16 per cent year-on-year to £60.8mn. Management blamed this on Facebook’s “de-prioritisation of news content” which led to a significant decline in page views. Meanwhile, although customers are still buying newspapers, print advertising sales tumbled by 18 per cent, meaning total print revenues were down 2.7 per cent. 

It’s not all bad news. The group has been on a money saving drive and has shrunk its adjusted operating cost base by 3 per cent, “partly offsetting the impact of lower revenue on operating profit”. Its efforts were helped by a welcome decline in the cost of newsprint, driven by lower energy prices. Nevertheless, adjusted operating profit still fell by 24 per cent year-on-year to £36.1mn. 

Statutory figures paint an even gloomier picture, with operating profit down 68 per cent at £11.1mn. This figure includes the legal costs of the recent phone hacking trial — the outcome of which is due in the autumn — and restructuring charges, which also weighed on the publisher’s operating cash flow. 

Another big challenge for Reach is the phasing out of third-party cookies. This development will make it trickier for companies to track people around the web, thus making it harder for publishers to flog ad space if they lack their own first-party data about readers.

Reach has now registered about 30 per cent of its UK audience, and said this is fuelling “directly sold, higher value advertising”. Around 40 per cent of digital revenue is now “data-driven”, and this number is expected to rise further as advertisers seek alternatives to third-party cookie based targeting. For now, however, this isn’t translating into digital growth and the majority of readers remain unregistered.

From a valuation perspective, Reach is tempting. Shares have fallen by 31 per cent since January, and the group trades on a forward price-to earnings multiple of just 3.1. However, we remain very wary of both the economic backdrop and the internal workings of the company.