Is GlaxoSmithKline’s dividend at risk of a cut?

GlaxoSmithKline Pfizer dividend cut

GlaxoSmithKline (LON: GSK) (GSK.L) shares have taken a beating since the company reported its Q3 results on 25th October, falling from above 1,500p to around 1,360p today. While the company reported earnings in line with consensus expectations, investors are concerned that Glaxo’s interest in Pfizer Inc could put the dividend at risk.

The pharmaceutical company declared a 19p dividend for the quarter and said that shareholders can continue to expect a payment of 80p per share this year, however it was comments made by Chief Executive Emma Walmsley that spooked investors. Here’s a look at what was said.

Q3 results dividend statement

“The Board has declared a third interim dividend for 2017 of 19 pence per share (Q3 2016: 19 pence per share).

GSK expects to pay an annual ordinary dividend of 80p for 2017.

GSK recognises the importance of dividends to shareholders and aims to distribute regular dividend payments that will be determined primarily with reference to the free cash flow generated by the business after funding the investment necessary to support the Group’s future growth.

The Board intends to maintain the dividend for 2018 at the current level of 80p per share, subject to any material change in the external environment or performance expectations. Over time, as free cash flow strengthens, it intends to build free cash flow cover of the annual dividend to a target range of 1.25-1.50x, before returning the dividend to growth.”

So no major surprises in the results statement. The company ‘expects’ to pay 80p this year and ‘intends’ to pay 80p next year.

Q3 earnings call

However, it was comments made by Chief Executive Emma Walmsley on the earnings call that have rattled investors. When asked if she could ensure that a potential Pfizer deal would carry no dividend risk, Ms Walmsley replied:

We confirmed our intentions to pay the dividend in 2017 of 80 pence and again in 2018 and then we will be returning to declaring the dividend quarterly and not giving a more specific outlook beyond that.

The market clearly didn’t like the lack of reassurance here, and the shares have fallen significantly since.

Low free cash flow

The outlook for GlaxoSmithKline’s dividend certainly looks opaque right now, in my view.

The company generated free cash flow of £1.6bn for the first nine months of the year. Dividend payments totalled £2.8bn. That’s clearly not sustainable.

If GlaxoSmithKline does look at acquisition options in order to boost its consumer health business, that is likely to put further strain on the dividend.

Analyst forecasts

Having said that, the consensus dividend estimate for FY2018 currently sits at 80.4p per share, suggesting that the majority of analysts do not forecast a dividend cut next year.

This is what Morningstar analyst Damien Conover had to say about Glaxo after the Q3 results:

We continue to view the stock as undervalued driven by steady growth in consumer health, vaccines, and HIV drugs, offsetting the expected 2018 US generic drug competition for respiratory drug Advair.

Analysts continue to view the firm’s significant competitive advantage – or wide moat – as secure, buoyed by brand power in the consumer group, innovation in drug and vaccine groups as well as some cost advantages layered into the vaccine segment.

We expect steady growth in the vaccine and consumer groups to help mitigate 2018 pressures in the drug group and help support the dividend, which is currently above 5%. While management has only confirmed a steady dividend through 2018, we believe a dividend cut is unlikely despite pressures the firms faces in 2018. However, concerns around the dividend will likely weigh on the stock price.”

Continuing to hold

Personally, I’ll be continuing to hold my GlaxoSmithKline shares for now. However, I am certainly not 100% convinced about the sustainability of the dividend, and will continue to monitor the situation closely.

Disclosure: Edward Sheldon, CFA owns shares in GlaxoSmithKline. 

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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