>GLAXOSMITHKLINE (EUROPEAN STOCK)

Improving outlook reflected in the price

■ Fundamental outlook improving but valuation full
Although we believe the outlook for GSK is slowly improving, we maintain our Neutral rating. A better pipeline, creative M&A that has not, to date, destroyed value (as we had feared) and the increasing reflection of generic Advair risk in consensus forecasts, thus minimising downside risks, have steadily improved our perception of the stock. However, despite this, we still expect margin and generic pressures to lead to earnings declines 2010-2013 leaving the stock fully valued at current levels hence our Neutral rating.

■ Improving outlook from pipeline and M&A
Key improvements in our view on GSK include: 1) Pipeline. Following positive Phase III data on Benlysta (lupus), Menhibrix (meningitis vaccine) we recently added £1.2bn in risk adjusted sales for these products to our model. Approval of both could lift 2015E EPS c8%. 2) GSK’s acquisition policy has, to date, not destroyed value as we feared. Acquisitions such as Stiefel have been largely value-neutral. “Capital-lite” deals such as product licensing from Aspen, and Ranbaxy and an HIV JV with Pfizer increase optionality and leverage GSK’s existing infrastructure. 3) Consensus Advair forecasts of £4.2bn in 2013 now reflect greater Advair generic risk reducing downside risks on generic newsflow.

■ Longer term margin pressure slows growth. Valuation full
However, our continued Neutral rating is predicated on: 1) Slow EPS growth outlook. Despite the improvements, we continue to forecast 10-13E EPS CAGR of -3% due to Advair generic competition from 2011 in EU and 2013 in the US, and margin pressures (faster growth of lower margin consumer and EM businesses, increasing sales of in-licensed products and price pressure in developed markets. 2) Valuation: GSK looks fully valued, trading close to our 1,200p DCF-based price objective and on a sector average P/E of c10x despite a significantly worse
growth outlook ’10-‘13E EPS CAGR of minus 3% vs the sector average of +5%.

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