GlaxoSmithKline’s (GSK, Financial) recent share price drop has pushed its dividend yield above the 5% mark, making it an extremely attractive dividend investment. But why is the market considering GlaxoSmithKline a risk and ready to reward investors with a 5%-plus yield? Let’s take a closer look to understand what’s behind GlaxoSmithKline’s current valuation and also a look at its balance sheet strength.
The first problem is GlaxoSmithKline’s revenue decline in the last five years. The pharma sector has been under pressure for some time now as patent cliffs, increasing cost of research and competition in the form generics have made life extremely difficult for all pharma majors. Pfizer (PFE, Financial), Novartis (NVS, Financial), GlaxoSmithKline and almost all the large pharma companies are struggling to get their revenues to grow at a steady rate, and all of them are buying pipelines and reorganizing their portfolios.
In a recent announcement, GlaxoSmithKline’s new CEO made it clear that the company is streamlining its R&D by ditching more than 30 drug projects. According to a Reuters report:
“Thirteen clinical and around 20 preclinical programs will be stopped, partnered or divested, and the group is considering options for its rare diseases unit after a strategic review.”
Reorganizations are never easy, and it will take time for the benefits to filter down to the bottom line. During the second quarter, group turnover increased 3% in constant currency. The balance sheet position was reasonably healthy as the company finished the second quarter with 3.9 billion British pounds ($5.039 billion) cash against long-term debt of 12.25 billion pounds.
GlaxoSmithKline paid 2.049 billion pounds as dividends during the quarter. Operating loss was 20 million pounds during the quarter, pushing the company to rely on its balance sheet to keep its dividends flowing. Though revenue has picked up, GlaxoSmithKline has a long way to go before it gets things back on track. The reorganization plan is, indeed, a good one, as it will cut spending, reduce the size of the company’s portfolio and, more importantly, help GlaxoSmithKline get its bottom line back on track.
The market realizes that the path to better top-line and bottom-line numbers is still not clear, and it will take time for GlaxoSmithKline to get that done. That is the reason why GlaxoSmithKline is yielding more than 5% – and rightly so, because there is good amount of risk involved. I would wait for at least a few more quarters to see how its portfolio streamlining works out before going after its high yield.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
