Invesco Perpetual’s Mark Barnett has sold out of pharmaceutical giant GlaxoSmithKline across his UK equity income funds and trusts, as the FE Alpha Manager sees “more innovation and growth potential” in other companies in the sector. 
Glaxo had been a longstanding holding of Barnett’s and going into 2015 the stock had been a top 10 holding in his Invesco Perpetual UK Strategic Income fund, as well as the Invesco Perpetual High Income fund, Invesco Perpetual Income fund and Edinburgh Investment Trust he inherited from Neil Woodford.
However, the manager had been trimming his exposure to the stock for some time and has completely sold out of it across all his portfolios during the past six months.
Healthcare still remains a strong theme within his funds; Invesco Perpetual High Income, for example, still has close to 20 per cent of its £12.5bn portfolio in the sector. AstraZeneca and Roche are top holdings in his funds and trust.
“We remain positive on the pharmaceutical sector, where we have a wide spread of investments. However we are looking to invest in in companies where we see more innovation and growth potential than we see in GlaxoSmithKline,” Barnett said.
As the graph below shows, Glaxo’s share price has fallen by close to 9.5 per cent over the past two years over concerns on the company’s business strategy, drug pipeline and dividend sustainability, although management has been eager to rebuff these worries.
This fall means the stock is lagging the FTSE 100, which has lost 1.33 per cent over the period, and is far behind the rise of more than 15 per cent in the FTSE Pharmaceuticals sector.
Performance of stock vs sector and index
Source: FE Analytics
The manager adds that he views Glaxo as being “structurally challenged at the moment”.
This is demonstrated through the company’s failure to stave off competition in its important US respiratory franchise, which accounted for 31 per cent of revenue in 2014 but Invesco expects to fall to 23 per cent in 2018. A decline of this magnitude would leave the firm with “a big hole to fill”.
Adding to this worry is the recent clinical trial of the Breo treatment for asthma and chronic obstructive pulmonary disease. The trial failed to show that the drug could extend the life of people with chronic breathing difficulties, lowering hope that Breo will be able to replace its successful Advair treatment.
Furthermore, Invesco Perpetual’s UK equity team says Glaxo’s drug pipeline has nowhere near the potential they see in AstraZeneca’s while his consumer business lacks “the same virtues” that can be found in something like Reckitt Benckiser.
Another concern from an equity income point of view is the fact that the company’s dividend is uncovered by earnings or free cashflow for the next two years. Although the firm has maintained its commitment to paying a dividend, it is one of the large-caps often cited by commentators as being at risk of a cut.
Not all commentators believe that Glaxo is facing significant difficulties. Helal Miah, investment research analyst at The Share Centre, highlights the company’s recent Q3 results as being a source of good news, after revenues beat analysts’ expectations by rising 9 per cent year-on-year.
Growth was reported in its pharmaceuticals and vaccines, consumer healthcare and HIV divisions while the firm said that sales of new drugs are offsetting the declines in established products such as Advair.
“We continue to recommend GlaxoSmithKline as a ‘buy’ for lower risk, income seeking investors,” Miah said.
“The company is demonstrating that its three key priorities, to diversify, deliver more products of value and simplify the operating model are working. As a result, the group has reiterated that it expects to achieve its guidance for the remainder of 2015 and 2016.”
However, today’s half-year financial report for the Edinburgh Investment Trust shows the stocks that Barnett has found to be more attractive than GlaxoSmithKline over recent months. The manager made new investments in easyJet, BCA Marketplace, VPC Specialty Lending and Zegona Communications during the six months to 30 September.
He also explains which stocks have contributed to the trust’s first-decile 6.58 per cent total return over the period.
Performance of trust vs sector and index over 6 months to 30 Sep 2015
Source: FE Analytics
Barnett says the “key contributors” to outperformance were his holdings in tobacco companies, especially Reynolds American and Imperial Tobacco. These are the trust’s two largest holdings.
Over the six months in question, Reynolds American’s share price rise by over 25 per cent after the US Federal Trade Commission approved its acquisition of US tobacco company Lorillard and saw it acquire the US’ dominant menthol cigarette brand Newport. As part of the deal, Imperial Tobacco acquired some US brands from Reynolds including premium brand Winston as well as Lorillard’s US based salesforce.
“Dividend growth and profit margins remain healthy across the tobacco majors, in spite of the continuing volume decline in global cigarette sales, as product innovation, tobacco quality improvements and cost rationalisation have helped to enhance pricing power in many territories,” the manager said.
Investments in the financial services sector also contributed to performance.
Amlin, a Lloyds insurance market investment vehicle, received a takeover approach from Japanese company Mitsui, which bolstered the share price, while the share prices of Beazley and Hiscox rose after on the back of positive half-year results and growing takeover speculation.
Provident Financial, which specialises in the non-standard lending market, also performed strongly thanks to the continued strength of its non-standard credit card business Vanquis and consumer credit division CCD.
But it was what Barnett didn’t own that helped performance just as much as what he did hold, during what turned out to be a volatile period for equity investors.
“The portfolio continues to have no exposure to banks or mining companies, mainly because of the uncertainty on the future direction of dividends as a result of regulatory restrictions in the case of banks, and uncertainty over future commodity prices in the case of mining companies,” he said.
“It was in part having no exposure to these sectors that helped drive the company’s outperformance of its benchmark during the period under review.”
Despite the strong performance of some of his holdings, the manager says that his outlook for the UK stock market is “subdued” on a near-term view and wants that the coming years are unlikely to be a repeat of the benign conditions experienced over recent years.
Four factors making the outlook more challenging are: the strong five-year performance of the FTSE All Share relative to its own history; the fact that UK equities are no longer a cheap asset class; weak underlying earnings growth in the market; and signs of deflation across the globe, stemming from China.
Performance of index over 5yrs
Source: FE Analytics
“These factors have combined to make the UK stock market a more volatile place to invest. However, this is also an environment which favours active portfolio management,” Barnett concluded.
“In the near term the outlook may indeed be more challenging as profit warnings and dividend cuts become a recurring feature of the landscape. The successful manager will need to tread carefully in this environment in order to avoid these pitfalls.”
