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This once good company has created two great ones – investors should own both

Pharmaceuticals
Pharmaceuticals

Market noise has been loud this year and it has been difficult for investors to look beyond the hysteria whipped up by their peers to focus on information and fundamentals. Sentiment has also been highly changeable, which has led to volatile stock prices that in many cases materially diverge from underlying business valuations.

The demerger from GSK, the drugs giant, of its consumer healthcare business, Haleon, in July was preceded and followed by large amounts of noise. Investors have raised concerns about various risks, including the financial position and long‑term growth potential of both businesses.

As a reminder, GSK shareholders received one Haleon share for each existing GSK share. Shortly after this, the latter’s shares were consolidated on a four‑for‑five basis to roughly maintain share price comparability before and after the demerger.

In Questor’s view, both companies offer excellent long‑term investment potential despite some investors’ misgivings about the demerger.

GSK, for example, can now focus on developing its pipeline of new drugs; its spending on research and development increased by 8pc in its latest quarter. Recent news regarding its pipeline has been mixed. For example, last month it took a blood cancer drug off the US market after a disappointing trial.

However, pharmaceutical firms have always lived and died by the success of their pipelines and GSK’s solid financial position gives it the capacity to raise investment over the long run to produce blockbuster drugs.

Its net finance costs were covered seven times by operating profits in the latest quarter. Strong financial performance allowed it to raise annual guidance and it now expects to generate sales growth of 8pc‑10pc and an increase in adjusted operating profits of 15pc‑17pc. This should make it an increasingly attractive proposition for investors at a time when many businesses are struggling to maintain, let alone raise, profits thanks to the uncertain economic outlook.

GSK’s relatively low correlation to the global economy’s near‑term prospects further enhances its investment appeal. Its shares’ lacklustre performance this year – they have fallen by 14pc – has made them excellent value for money at a forecast price‑to‑earnings ratio of 10.6.

Haleon’s shares also offer significant long‑term capital growth potential. Its debt levels have repeatedly been cited by investors as a cause for concern. However, the business has a net‑debt‑to‑equity ratio of just 33pc and its finance costs were covered 11 times by operating profits in the first half of the year. Both figures suggest that the company is very unlikely to experience financial challenges.

Its latest quarterly update showed that the company’s growth strategy was bearing fruit. Organic revenues in the first nine months of the year increased by more than 10pc and this led Haleon to raise its guidance for the full year. It was also able to fully offset inflationary pressures via price rises and efficiencies; high levels of consumer loyalty towards brands such as Sensodyne and Panadol offer a clear and sustainable competitive advantage.

Haleon’s investment in e‑commerce provides a long‑term growth catalyst as consumers increasingly switch to digital sales, which now account for 9pc of revenues and are growing at a mid‑teens percentage rate. The shares currently trade at around 15.5 forecast earnings, so they appear to offer good value for money given the size of the company’s economic “moat” and long‑term growth potential in emerging markets.

Both companies face potential legal issues from previous sales of a heartburn drug called Zantac, which may have caused cancer in some users. This could hold back their share prices in the short term, but looks well factored into their current market values following recent falls.

Since our first recommendation in January 2019, an investment in GSK has produced a 3pc capital loss when Haleon’s current value is included. Given the long‑term growth prospects, solid financial position and strong recent performance of both companies, now is an opportune moment for existing investors to top up and for new investors to buy.

Questor says: buy
Ticker: GSK, HLN
Share price at close: £13.88, 295.2p

Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

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