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Robert Abbott
Robert Abbott
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Is GlaxoSmithKline’s Dividend Enough to Offset Its Slowing Cash Flow?

A drug manufacturer with a high-yield dividend, but some concerning fundamentals

July 06, 2020 | About:

Meet a drug company with an extraordinary return on equity: GlaxoSmithKline PLC (NYSE:GSK).

GuruFocus GSK return on equity chart

Its return on equity is extremely volatile, ranging from 25.14% for 2016 to 313.03% for 2017. That makes 2019s return on equity of 61.7% appear almost normal. But, of course, we know few companies have such a high return on investors money.

Does that make it an immediate buy stock, especially since its dividend falls into the category of high-yield? More than a dozen gurus apparently think so, and it does have a place on the High-Yield Dividend Screener & High-Dividend Yield Stocks in Guru's Portfolios lists.

GlaxoSmithKline, as the name suggests, is an aggregation of companies. But even the name does not do justice to the many businesses that have become part of it over the past century and a half. It took on its current configuration in 2000 when Glaxo Wellcome and SmithKline Beecham merged.

Todays company, based in the United Kingdom, has three global businesses:

  • Pharmaceutical with 2019 revenue of 17,554 pounds ($21,932.58).
  • Vaccines, with 2019 revenue of 7,157 pounds.
  • Consumer Healthcare, with 2019 revenue of 8,995 pounds.

The vaccines arm is among the organizations and companies trying to develop and get approval for a new coronavirus vaccine. To expedite that project, it negotiated partnerships with two other organizations.

Regarding the consumer health care business, GlaxoSmithKline and Pfizer (NYSE:PFE) announced and completed a joint venture integrating their two consumer divisions.

Looking at its fundamentals, we see a mixed picture:

  • Financial strength: 4 out of 10
  • Profitability: 8 out of 10
  • Valuation: 6 out of 10.

Its financial strength rating is pulled down by its long-term debt, which is illustrated in this GuruFocus chart:

GuruFocus GSK debt

Still, it has an interest coverage ratio of 7.85, meaning it is generating more than enough operating income to cover its income expenses.

GuruFocus GSK financial strength

In addition, it has a lopsided return on invested capitval versus weighted average cost of capital ratio, favoring the ROIC side. Its ROIC works out to 9.05%, much higher than the WACC at 3.4%. This means it is earning more on the funds it has raised and borrowed than it is costing to borrow.

On the profitability side, we see a high rating driven by strong margins:

GuruFocus GSK profitability

With ROE of more than 60% and margins above 15%, it obviously has a moat, or competitive advantage, that allows it to maintain its pricing power. In GlaxoSmithKlines case, it has a moat for drugs and other products covered by patents; however, patents do expire and drugs that were once blockbusters are challenged by generics. The key is to maintain a pipeline of very promising new drugs, which it appears the company is doing.

Valuation gets a medium rating because its price-earnings ratio (among other indicators) is in the mid-teens:

GuruFocus GSK valuation

The PEG ratio clocks in at a high 3.43, while the discounted cash flow calculator shows the stock to have a negative margin of safety (the current stock price is $41.22, but fair, or intrinsic, value is estimated as $29). Note, though, that the company has a 1 out of 5 rating for predictability, so confidence in the DCF figure is quite limited.

It looks like investors have bid up the price of GlaxoSmithKline beyond its intrinsic value because they see something they like. Could that be dividends?

Dividend yield

One of the reasons they may like this stock is its nearly 5% yield at the close of trading on July 2:

GuruFocus GSK dividend table

As this chart shows, the yield inversely mirrors the movement of the stock price

GuruFocus GSK price and dividend yield chart

Despite that, we note that the yield has not fallen below 4% in the past 10 years.

Dividend payout ratio

The payout ratio is high at 74%. But it has been higher.

GuruFocus reports the ratio has ranged between 4.6% and 430% over the past decade, while the median was 98%. Therefore, we would have to assume todays dividend is more sustainable than it has been in the past.

And as the following chart shows, GlaxoSmithKline's (darker green) ratio is somewhat conservative for the drug manufacturers industry:

GuruFocus GSK payout ratio

Behind the payout ratios sustainability is the level of free cash flow; the following chart indicates the companys free cash flow has been on a roller coaster, but the trend is downward:

GuruFocus GSK free cash flow chart

Forward yield

Since the forward yield is slightly lower than the trailing 12-month yield, we expect the company to have cut its most recent dividend payment.

That turns out to be the case, but we learn from a company-provided table that there is quite of bit of variation from quarter to quarter:

GuruFocus GSK dividend history

Five-year yield on cost

If you were to buy shares of GlaxoSmithKline now and hold them for five years, and the company was to maintain the same level of dividends for the next five years as it has for the past five, then you would expect returns to average 4.6% per year.

But the company has not steadily grown or maintained its dividends, so there is little value to this piece of data.

Share buybacks

Because the buyback ratio is negative (-0.5), we know the company issued more shares than it repurchased over the past five years.

In fact, this chart shows us how the share count dipped earlier in the decade, and then came charging back up:

GuruFocus GSK shares outstanding chart

Dont expect to make any gains based on share buybacks; indeed, you should prepare for the possibility your holding will be diluted by the issuance of new shares.

Gurus

Of the gurus followed by GuruFocus, 15 have positions in GlaxoSmithKline. By far the biggest position at the end of the first quarter was Dodge & Cox with 44,035,690 shares, representing 1.76% of the companys capital and 1.81% of the investment firms capital.

The second-largest holding was that of Jim Simons (Trades, Portfolio)'s Renaissance Technologies with 23,076,454 shares and third was Ken Fisher (Trades, Portfolio) of Fisher Asset Management with15,539,965 shares.

Guru buys and sells were nearly equal in the first quarter of this year.

Conclusion

For income investors, GlaxoSmithKline has several attractive qualities, including a high ROE, a strong following among the gurus and a dividend of nearly 5%

There are also reasons for concern. The company has been growing its debt, while its free cash flow has been drifting down.

Taking the pros and cons together, this drug manufacturer has some charms, but there are better choices for income investors.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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