On July 18, GSK PLC (GSK, Financial) completed the long-awaited spinoff of its consumer health care business, Haleon PLC (HLN, Financial). By separating the slow but steady consumer health business from the higher risk-reward pharmaceutical business, the spinoff was expected to drive GSK’s stock valuation multiples higher, allowing it to fund more drug development and acquisitions.
At the time of the spinoff, many investors treated Haleon as dead weight that GSK was getting rid of. However, the situation has changed since then for two main reasons. For one, the stock market has turned away from growth stocks and now favors cash-generators due to economic uncertainty and rising interest rates, an environment which favors risk-off stocks such as Haleon. Secondly, Haleon has reported impressive results for its first few months as an independent company, showing its ability to grow even in a tough operating environment. These factors have helped boost Haleon’s shares to near their initial spinoff price at $7.64 apiece:
Let’s take a closer look at Haleon’s recent developments to see why the stock could be fundamentally underestimated by the market.
Haleon reports impressive growth
In its report for the first six months of 2022, Haleon achieved revenue growth of 13.4%. In particular, the Panadol, Theraflu, Otrivin, Advil and Centrum brands showed strong growth. Approximately two-thirds of its businesses either gained or maintained market share. The e-commerce segment made up 9% of sales, reporting high-teens growth for the half-year. Operating profit grew 22.1%, with the operating margin expanding 120 basis points to 17.3%.
More recently, the company released a trading statement for the three months ended Sept. 30. Revenue for the quarter was even better than the first half of the year, up 16.1%. Operating profit improved 12.2%, though the operating margin was down 70 basis points from the year-ago period to 19.7%.
The company reports that its oral health and respiratory segments continue to show some of the strongest growth. The oral health segment is showing strong growth in emerging markets such as the Middle East and Africa, while the respiratory segment continues being boosted by flu resurgences as well as the Covid-19 pandemic (as Covid causes long-term respiratory issues in some patients).
The biggest drawback to growth was currency exchange. Due to the strong dollar, the company’s highest currency-neutral growth region, North America, became its lowest growth region after adjusting for currency exchange (18.5% growth reported versus 2.9% constant-currency growth).
Proactive cost and risk management
Underpinning Haleon’s stellar results is the company’s incredible performance in managing its costs and risks post-spinoff.
Growth in its products, price increases and efficient cost management have allowed the company to improve its margins, thus keeping up with inflationary costs. Haleon is taking advantage of the growth in its free cash flow to pay down debt, which is a wise move.
In addition to costs, Haleon is also taking important steps to mitigate its risk. One of the main risks investors are worried about is the company might end up getting saddled with costs from Zantac litigation. Haleon’s parent company and Sanofi (SNY, Financial) sold Zantac, which was found to unexpectedly contain a probable carcinogen in a 2018 safety review.
As Haleon was founded in 2018 as part of a joint venture between GSK and Pfizer (PFE, Financial), it has rejected indemnification claims on the grounds that neither of the companies’ consumer health segments sold Zantac in the U.S. or Canada at the time of the joint venture’s founding. While GSK is trying to foist some of the responsibility off on Haleon in order to protect itself, Haleon argues that “the joint venture agreement only covers their consumer health care businesses as conducted when the JV was formed in 2018.”
While it it still possible that inflation, currency exchange or Zantac litigation could negatively impact Haleon in the future, it is an encouraging sign that the company seems to be managing these risks well post-spinoff.
Outlook and valuation
Haleon’s stock was trading around its initial listing price as of this writing at $7.64 per share, giving it a price-earnings ratio of 17.87 and a market cap of $33.18 billion. Given the company’s growth this year and its guidance for revenue growth of 8% to 8.5% for full fiscal 2022, the price-earnings ratio seems fair. Morningstar (MORN, Financial) analysts estimate the stock’s future three-to-five-year revenue growth rate at 7.29%.
Given that the lock-up period ended in November, investors were keeping an eye on the share price to see if insiders would begin to dump shares on the open market. However, after just a tiny dip at the end of November, the stock resumed its uptrend, so it does not seem likely that a ton of insiders decided to jump ship.
Prior to the spinoff, when the bull market was still in full swing, GSK was considering selling Haleon to another company, but it rejected an offer from Unilver (UL, Financial) to buy the consumer health business for $68 billion because it believed the offer “fundamentally undervalued” Haleon’s potential. In other words, GSK’s management estimated Haleon’s fair value at twice its current market cap, which is a positive sign.
We are no longer in a bull market, though, and it is possible that GSK was just trying to take advantage of the hot market to see if it could attract a better bid.
Takeaway
Haleon has been performing better than expected since it spun off from GSK. It appears the market has warmed up considerably to the stock as the macroeconomic environment now favors safety over growth, and while some danger remains from factors like cost inflation and Zantac, the stock seems fairly valued relative to its near-term outlook and undervalued based on GSK’s estimates of its long-term potential. Thanks to the strength of its brands, pricing power and growth in all key regions, Haleon seems to be doing a good job of proving that it can stand on its own.
