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Why the GSK share price should smash the FTSE 100 this year

Roland Head
Compass pointing towards 'best price'

Shares of pharma giant GlaxoSmithKline (LSE: GSK) have risen by 15% so far this year, outpacing a flat performance from the FTSE 100.

I first suggest this stock as a turnaround buy back in January and then again in March when news broke of the group’s decision to buy out Novartis from the pair’s consumer healthcare joint venture for $13bn.

At that time the stock was trading on around 12 times 2018 forecast earnings and offering a 6% yield. The group’s rising share price has upped this price tag. Glaxo shares now trade on 14 times 2018 forecast earnings, with a 5.3% yield.

For comparison, the FTSE 100 currently trades on a P/E of 13.5 with a dividend yield of 3.8%. So Glaxo looks still reasonably priced compared to the index. And the group may also have some tricks up its sleeve.

Staying together could be profitable

A number of prominent investors including Neil Woodford have called for the group to break itself up into two or three smaller and more focused businesses. I have some sympathy with this view, but it seems that chief executive Emma Walmsley isn’t keen.

Ms Walmsley appears determined to keep the group together and improve its performance by bulking up in key areas of strength. The acquisition of the remaining share of the Consumer Healthcare joint venture is an example of this.

This decision isn’t without risk. Much of the $13bn recently paid to Novartis for its share of the consumer healthcare business was funded with debt. But the operating margin from selling products such as Panadol and Sensodyne is expected to rise from 17.7% in 2017 to “mid-20s percentages” by 2022.

I estimate that achieving this alone could add about £550m to Glaxo’s 2017 operating profit of £4.1bn, even before any sales growth is considered.

I still see value

At Glaxo’s current valuation, I believe the shares still offer decent value for long-term income investors. Although this group has underperformed the market over the last five years, profits seem to have stabilised and free cash flow is improving. This should support both the dividend and some level of debt reduction.

For income investors, I believe Glaxo’s 5.3% yield represents a decent buy.

This 6% yielder could motor ahead

Public transport operators are not exactly the flavour of the month at the moment. Many rail commuters will know why. But my pick from this sector, FTSE 250 firm Go-Ahead Group (LSE: GOG), looks like a potential value buy to me.

As with Glaxo, Go-Ahead’s share price has motored ahead this year. The stock is now worth about 10% more than at the start of January.

What’s changed?

The group’s troubled Southern Rail franchise has gathered a lot of headlines. But the reality is that the financial results of the rail division were ahead of expectations during the six months to 31 December. The group’s bus operations are also performing well and a number of new overseas contracts are in the pipeline.

Revenue rose by 6.6% to £1,829.4m during the half-year, while operating profit climbed 19% to £86.9m. The group’s third-quarter trading statement shows that this performance has continued, with profit guidance left unchanged for buses and upgraded for rail.

A cash machine

The company seems to be leaving last year’s problems behind. And its financial performance is improving. Cash generation has always been a core attraction here and this is starting to recover, after a difficult period in 2016/17.

I estimate that Go-Ahead’s forecast dividend of 102p per share should be covered by free cash flow this year. With a 2017/18 price/earnings ratio of 8.9 and a forecast dividend yield of 6.1%, this stock is on my buy list at the moment.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.