Analysis of the profitability of the UK based global pharmaceutical company GSK PLC

Analysis of the profitability of the UK based global pharmaceutical company GSK PLC

Introduction
This paper seeks to analyze and compare profitability ratios of GlaxoSmithKline PLC (GSK) and Novartis International AG a Swiss multinational pharmaceutical company based in Basel, Switzerland. Financial ratios will be used as the basis of analysis as they can give the underlying financial health of a company.
The pharmaceutical industry
The pharmaceutical industry is rapidly growing because of the ongoing changes in the social, political, economic, technological and legal environment in health care market. The Pharmaceutical Drugs Global Market Report (2018) shows that the global pharmaceuticals market was worth $934.8 billion in 2017 and is expected to grow at a rate of 5.8% with expected revenues of up to $1170 billion come 2021.The industry is dominated by competitive firms that competitively seek to have a share of the market. Large corporations are involved in tech based research producing vaccines and medicines, while smaller corporations are concentrating on producing generic medicine.
Overview of the Companies
Novartis International AG located in Basel, Switzerland is one of the largest multinational pharmaceutical company in the world. The company operates under several divisions around the world and concentrates on pharmaceutical, generic medicine and eye care. On the other hand, GlaxoSmithKline PLC is also a large multinational pharmaceutical company located in the UK that wields its might in producing pharmaceutical products including over the counter medicine, antivirals, vaccines and health care related products.
The profit margin
The profit margin measures a company’s internal profitability by evaluating its ability to generate income. The following graph compares the operating margin of the two companies.
Figure 1: Operating Margin
Source: Calculated Ratios from Annual Reports (2017)
Figure 1 shows that the profit margin did not change significantly in the year under analysis. Novartis International AG, had an average operating margin of about 17% in the three years. Glaxo Smith Kline operating average was also about 17%. However, Glaxo Smith Kline operating margin was slightly higher than that of Novartis International AG. In fact, Glaxo Smith Kline’s operating margin has been increasing steadily from 2015 to 2016 before falling to about 20% in 2017. On the other hand, Novartis International, operating margin has been relatively stable over the years with insignificant changes. In 2016, Novartis International AG reported a margin of 16.72% while Glaxo Smith Kline’s stood at 21.61. Even though the margins are not that high, positive increment over the years suggests that both companies have better productivity as well as better control of the cost of sales (Van Horne and Wachowicz, 2001). According to Glaxo Smith Kline (2017) annual report, changes in operating margin are attributed to the “pressure on prices in the US, investments in marketing and sales in key markets outside the US, and higher manufacturing restructuring charges” (34). Nevertheless, the company’s operating profit rose to £4,087 million in 2017 compared to £2,598 million in 2016 which is attributed to increased productivity in all the segments and re-measurement of liabilities and contingent considerations.
On the other hand, Novartis International AG attributes the changes in its operating income to “lower amortization and a gain from achievement of a sales milestone related to the 2015 Vaccines divestment to GSK more than offset generic erosion as well as currency differences” (Novartis International AG,2017: 56).
Earnings Per Share
Price Earning per share is used to evaluate whether a company’s shares are under or overvalued. High P/E ratios may interest investors and also a positive sign for growth in earnings with lower P/E ratios showing that companies are undervalued and therefore risky for prospective investors (Titman et al., (2016).
Figure 2: Earning Per Share (EPS)
Source: Calculated Ratios from annual reports (2017)
EPS for both companies have been rising from 2016. Novartis International AG EPS is much higher than Glaxo Smith Kline. In 2016, the EPS for Novartis International AG stood at 2.8 % while that of Glaxo Smith Kline was at 0.18 and 0.31 in 2016 and 2017 respectively. The differences in EPS can be attributed to market capitalization with Novartis International AG’s being higher than the later. Furthermore, Glaxo Smith Kline annual report (2017) indicates that the increase in EPS reflects changes related to accounting for contingent liabilities, preferential dividends, and put options associated with “the Group’s HIV and
Consumer Healthcare businesses, the benefit from Swiss tax reform and improved performance by the relevant businesses”) and re measurement of contingent considerations.
Return on Capital Employed
This ratio measures a company’s efficiency of generating earnings to increase shareholders wealth. A high ROCE shows that a company is effective in utilizing earnings to benefit the shareholders. In addition a high ROCE is also a sign of growth (Titman et al., 2016).
Figure 3: Return on Capital Employed
Source: Calculated Ratios from http://financials.morningstar.com/ratios/r.html?t=NVS®ion=usa&culture=en-US
From the figure above, ROCE has been increasing for both companies. In 2016 Novartis International AG had a ROCE of 7.68% which increased to 8.02 in 2017.Glaxo Smith Kline ROCE is generally much higher than Novartis International AG. The company’s ROCE doubled from 6.51% in 2016 to 14.17% in 2017.The company attributes utilization of shareholders’ funds to their capital allocation and investment appraisal program. According to Glaxo Smith Kline (2017; 76 ), the company has strengthened its framework of capital allocation in that it has put in place a board that is responsible for governing the allocation of business. Furthermore, the company utilizes a cash return on invested capital (CROIC) methodology that prioritizes consistent investment across the group.
Conclusion
In light of the above analysis both companies seem to have a strong financial position. It’s impossible to clearly rank one company as outperforming the other as each utilizes its own competitive advantage to have an edge in the market. The ROCE and profitability margins are higher for Glaxo Smith Kline, whereas Novartis International has a higher EPS. Though the latter has a higher EPS, investors wanting a return on their capital should invest in Glaxo smith Kline has it has in place capital allocation and investment framework. Nonetheless, both companies have restructured their operations and therefore investing in both companies can be rewarding. Moreover, analysts predict an astronomical growth in the industry following changes and health reforms in health care in and out of the USA.
References
GlaxoSmithKline PLCGLAXF(2017). Annual Report [online] Available at https://www.gsk.com/media/4751/annual-report.pdf [Accessed 27 Jan. 2019].
Novartis International (AAPL) . (2017). Annual Report [online] Available at https://www.novartis.com/sites/www.novartis.com/files/novartis-annual-report-2017-en.pdf[Accessed 27 Jan. 2019].
Pharmaceutical Drugs Global Market Report (2018). Retrieved from https://www.marketresearch.com/Business-Research-Company-v4006/Pharmaceutical-Drugs-Global-Musculoskeletal-Disorder-11518658/?progid=90731
Stock Analysis on Net. (2019). GlaxoSmithKline PLCGLAXF | Financial Ratios. [online] Available at: http://financials.morningstar.com/ratios/r.html?t=GLAXF®ion=usa&culture=en-US[Accessed 28th Jan. 2019].
Stock Analysis on Net. (2019). Novartis AG ADRNVS| Financial Ratios. [online] Available at: http://financials.morningstar.com/ratios/r.html?t=NVS®ion=usa&culture=en-US [Accessed 28th Jan. 2019].
Titman, S., Martin, T., Keown, A. and Martin, J. (2016). Financial management Principles and Applications. 7th ed. Melbourne: Pearson Australia.
Van Horne, C.J and Wachowicz, J.(2001). Fundamentals of Financial Management, (11th ed). Prentice Hall
Appendix: Financial Statements

NOVARTIS AG ADR(NVS) CashFlowFlag INCOME STATEMENT
Fiscal year ends in December. USD in millions except per share data. 2015-12 2016-12 2017-12
Revenue 50387 49436 50135
Cost of revenue 17404 17520 17175
Gross profit 32983 31916 32960
Operating expenses
Research and development 8935 9039 8972
Sales, General and administrative 14247 14192 14997
Other operating expenses 824 417 362
Total operating expenses 24006 23648 24331
Operating income 8977 8268 8629
Interest Expense 655 707 777
Other income (expense) -188 256 1147
Income before taxes 8134 7817 8999
Provision for income taxes 1106 1119 1296
Net income from continuing operations 7028 6698 7703
Net income from discontinuing ops 10766
Other -11 14
Net income 17783 6712 7703
Net income available to common shareholders 17783 6712 7703
Earnings per share
Basic 7.4 2.82 3.28
Diluted 7.29 2.8 3.25
Weighted average shares outstanding
Basic 2403 2378 2346
Diluted 2438 2400 2371
EBITDA 14260 14567 15852
GLAXOSMITHKLINE PLC(GLAXF) CashFlowFlag INCOME STATEMENT
Fiscal year ends in December. GBP in millions except per share data. 2015-12 2016-12 2017-12 TTM
Revenue 23923 27889 30186 30263
Cost of revenue 8853 9290 10342 9895
Gross profit 15070 18599 19844 20368
Operating expenses
Research and development 3560 3628 4476 4026
Sales, General and administrative 9232 9366 9672 9828
Other operating expenses -350 -421 -365 99
Total operating expenses 12442 12573 13783 13953
Operating income 2628 6026 6061 6415
Interest Expense 655 671 698 707
Other income (expense) 8553 -3416 -1838 -1840
Income before taxes 10526 1939 3525 3868
Provision for income taxes 2154 877 1356 1485
Net income from continuing operations 8372 1062 2169 2383
Other 50 -150 -637 -521
Net income 8422 912 1532 1862
Net income available to common shareholders 8422 912 1532 1862
Earnings per share
Basic 1.74 0.19 0.31 0.38
Diluted 1.72 0.18 0.31 0.38
Weighted average shares outstanding
Basic 4831 4860 4886 4919
Diluted 4888 4909 4941 4919
EBITDA 12811 4384 6145 4575
GLAXOSMITHKLINE PLC(GLAXF) CashFlowFlag BALANCE SHEET
Fiscal year ends in December. GBP in millions except per share data. 2015-12 2016-12 2017-12
Assets
Current assets
Cash
Cash and cash equivalents 5830 4897 3833
Short-term investments 75 89 78
Total cash 5905 4986 3911
Receivables 3824 4615 4672
Inventories 4716 5102 5557
Prepaid expenses 307 335 308
Other current assets 1835 1673 1459
Total current assets 16587 16711 15907
Non-current assets
Property, plant and equipment
Gross property, plant and equipment 20750 22164 21719
Accumulated Depreciation -11082 -11356 -10859
Net property, plant and equipment 9668 10808 10860
Goodwill 5162 5965 5734
Intangible assets 16672 18776 17562
Deferred income taxes 2905 4374 3796
Prepaid pension benefit 258 313 538
Other long-term assets 2194 2134 1984
Total non-current assets 36859 42370 40474
Total assets 53446 59081 56381
Liabilities and stockholders’ equity
Liabilities
Current liabilities
Short-term debt 1285 4106 2802
Capital leases 23 23 23
Accounts payable 3120 3596 3528
Taxes payable 1421 1305 995
Other current liabilities 7568 9971 19221
Total current liabilities 13417 19001 26569
Non-current liabilities
Long-term debt 15277 14620 14221
Capital leases 47 41 43
Deferred taxes liabilities 1522 1934 1396
Accrued liabilities 64 66 104
Pensions and other benefits 3229 4090 3539
Minority interest 3764 3839 3557
Other long-term liabilities 11012 14366 7020
Total non-current liabilities 34915 38956 29880
Total liabilities 48332 57957 56449
Stockholders’ equity
Common stock 1340 1342 1343
Additional paid-in capital 2831 2954 3019
Retained earnings -1397 -5392 -6477
Accumulated other comprehensive income 2340 2220 2047
Total stockholders’ equity 5114 1124 -68
Total liabilities and stockholders’ equity 53446 59081 56381

Calculations
Operating Margin
Operating Margin % is calculated as Operating Income divided by its Revenue.
Novartis AG’s
Operating Margin = Operating Income (A: Dec. 2017)/Revenue (A: Dec. 2017)
=8629/50135
=17.21 %

2015 2016 2017
Glaxo smith Kline revenues 27,889 30,186
operating income 6,026 6,061
O. Margins 0.216071 0.200788
Novartis AG’s revenues 50387 49,436 50,135
operating income 8,977 8,268 8,629
17.82 16.72 17.21

Earnings Per Share (EPS)
EPS (Basic) is a rough measurement of the amount of a company’s profit that can be allocated to one share of its stock. Basic earnings per share (EPS) do not factor in the dilutive effects on convertible securities.
Basic EPS (A: Dec. 2017 )=(Net Income-Preferred Dividends)/Shares Outstanding (Basic Average)
=(7703-0)/2346.000
=3.28
2016___6,712/51548.16
==2.8
Glaxo Smith Kline:
2016= 912/19708.32 =21.61
2017= 1532/ 30762.56=20.08