GlaxoSmithKline PLC’s (GSK) near 6% dividend yield is nothing short of mouthwatering. The British pharma major’s stock price has been on a steady downward slide for the past three years as the company struggled to achieve revenue growth. With questions arising in regard to the company’s dividend as the payout ratio went over 100%, it has added more downside pressure on the stock.
Glaxo is still going through a difficult period as patent expirations have hurt its top drugs. Revenues decreased from 26.43 billion pounds ($35.5 billion) in 2012 to 23.90 billion pounds in 2015, before recovering to 27.89 billion pounds in 2016.
The company managed to keep things moving during the first nine months of the current fiscal, reporting 22.547 billion pounds in revenue compared to 20.303 billion pounds last year, a growth rate of 11%. The company held 14.29 billion pounds in long-term debt against a cash holding of 4.78 billion pounds. While that may not look like too much of a debt mountain for a company that makes more than 27 billion pounds in annual revenues, the problem GlaxoSmithKline is currently facing is the size of its dividend payout.
As pharma giants around the world continue to struggle to find new revenue sources, buying pipelines is often seen as the easiest way to improve sales numbers. But big-ticket acquisitions will invariably end up increasing the debt pile.
Glaxo paid 2.977 billion pounds in dividends in the first nine months of the current fiscal, which was nearly half a billion more than the profit of 2.532 billion reported for the period.
The company has promised to hold its 80 pence per share in dividends until 2018, but the odds of free cash flow outgrowing dividend payouts within the next two years are very slim considering the free cash flow was only 1.6 billion pounds in the first nine months of the current year.
The company still has plenty of good products and a reasonably diversified revenue stream, with Pharma accounting for 58% of the company’s revenues, followed by Consumer HealthCare division with 26% and Vaccines accounting for the other 16%. The company has survived a challenging period and might be well on its way to recovery, but the dividend situation is certainly not.
In a recent press release, the board indicated it plans to maintain the current dividend for 2018. Over time, Glaxo hopes to build up free cash flow in order to achieve further dividend growth.
Getting the free cash flow to cover the annual dividend to is not going to be easy unless revenue growth picks up some serious momentum. Cutting the dividend in half, however, will get them closer to their target. It would be in GlaxoSmithKline’s best interest to cut its dividend sooner rather than later, free up some cash flow to reinvest in the business and take care of the assets that will help future growth.
This possibly explains why the yield is hovering around 6%, because there is a good chance it will come down within the next two years.
Disclosure: I have no positions in the stock mentioned above and have no intentions of initiating a position in the next 72 hours.
