Is GlaxoSmithKline’s 6% dividend sustainable?

There are some amazingly high dividend yields on offer these days, most notably from some of the largest blue-chip shares in the market.

The question, as always, is whether or not those massive yields are sustainable.

Take GlaxoSmithKline as an example.

It is one of the world’s leading pharmaceutical companies, it has a market cap of £68 billion and its record of increasing or at least holding the dividend goes back into the last century.

And yet this keystone of many a portfolio (including a certain Mr Neil Woodford) is available to buy with a dividend yield approaching 6%.

That’s an income of 6% from a company where the dividend has grown by almost 6% a year over the past decade and more.

So why is Glaxo available with such a high dividend yield when other blue-chip dividend growth stocks, like beverage giant SABMiller, can only manage a paltry 1.7% yield?

The answer, of course, is that the market expects Glaxo’s dividend to be cut and SABMiller’s to continue to grow rapidly for many years.

But the gap between Glaxo’s and SABMiller’s yields is so large it looks as if the market doesn’t just expect Glaxo to cut and SABMiller to grow, it is virtually certain; as if no alternative outcome were even possible.

Such unerring certainty is unusual, and I think that perhaps some other factor is at play.

What we might be seeing, rather than an excess of crystal ball-gazing certainty, is a split in the market.

The split is between those investors whose primary focus is on predictable earnings and dividend growth and those for whom such growth is a secondary or even irrelevant factor.

Tony Yarris of Wise Investments summed up this market bifurcation nicely in a recent article.

His position is that the financial crisis made investors more cautious, and as a result, many of them homed in on predictable growth companies.

These companies tend to provide repeat-purchase products or services like household consumables (e.g. beer in the case of SABMiller) or subscription software from companies like Sage (which I reviewed recently for

Companies in that predictable sweet spot have seen their valuations explode upwards. SABMiller for example has gone from about 1,000p pre-2009 crisis to 4,000p today.

On the other hand, Yarris suggests that dividends, for whatever reason, have fallen out of favour.

For the predictable growth companies, dividend yields are tiny, but that doesn’t matter because their growth is predictable and that’s all that matters (according to this world-view).

Companies like Glaxo may well offer a 6% yield, but the dividend has a question mark hanging over it, even though the company has reaffirmed its commitment to sustaining the dividend and in fact announced a special dividend to go on top of that 6% basic dividend.

But no matter. Growth is not certain and so the predictable growth crowd are not interested.

As a result, where dividend growth is less than 100% certain, companies are trading with yields that are normally reserved for basket cases.

In some ways, this is a problem.

It makes it harder to differentiate between quality dividend-payers who are simply having a bit of short-term trouble, and those companies that really are value traps, with dividends that are almost certain to go the way of the Dodo.

Unfortunately, there is no way to know for sure which is which, but there are a few things you can look for.

Here are some of my investing rules of thumb which are relevant in this situation (to find out more about the investment strategy into which these rules of thumb are built, have a look at these free resources).

Be wary of a company that:

  • Has skipped a dividend in the last ten years
  • Has failed to grow its revenues, earnings and dividends more than 50% of the time over the last ten years
  • Has total borrowings greater than five-times its five-year average profits
  • Has total pension liabilities greater than ten-times its five-year average profits
  • Has spent more on acquisitions this year than it earned in profits
  • Has repeatedly spent more on acquisitions over the past ten years than it earned in profits
  • Has a tendency to acquire companies that have little to do with its core business
  • Has recurring capital expenses that are greater than its profits
  • Has low levels of profitability, especially if ROCE is consistently below 7%
  • Has no obvious competitive advantages

Glaxo currently manages to pass all of those tests, so in my opinion, it is not obviously a value trap, even if it does have a 6% dividend yield.

Of course, I do not know if it will cut, hold or even grow its dividend over the next five years, but for now I am happy to keep Glaxo in both my personal portfolio and the UKVI model portfolio.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

23 thoughts on “Is GlaxoSmithKline’s 6% dividend sustainable?”

  1. I used to understand farmaceutical companies, but what happened last year with GSK was over the top. Initial there was talk about an IPO of the HIV business and afterwards a swap of assets with Novartis.

    The swap made it impossible to follow the numbers, understand margins etc. So I sold last year my GSK stock in tranches. I did the same with ANZ. I do have a few residual shares in a few other healthcare stocks, but the only position I hold is in Gilead, probably the company with the highest ROCE in this industry.

    Very few people understand there was a bull run in the healthcare and biotech sector. Many pharma companies were involved (or sucked in) in M&A with $80 billion spent in the last few years. There were inflated prices out there, and I am not quite sure the buyers will make a return on those investments.

    Neil Woodford, who is a kind of insider, believed the GSK dividend will be maintained. He may be right, but paying 6% won’t be such a good idea for GSK, unless the numbers start improving this year.

    1. Hi Eugen, yes I totally agree that these huge, extremely complex companies can be incredibly difficult to understand. In fact I think it is probably impossible for most people to understand then in detail.

      However, I’m happy to understand then “enough” so that I can make a reasonably informed investment decision, in the same way that I’m happy to drive a car or ride in a ship without really understanding what’s going on underneath.

      As for M&A, yes we’ll have to wait and see and there are a few years of the patent cliff to still get through yet.

    2. Hi Eugen, You might want to review Gilead, as it’s leading drug has just had a serious competitive alternative as introduced by Merck and 40% lower cost than Gilead.

      1. Merck’s competitor is only in stage 3. The trial showed that it works best when used together with Sovaldi (Gilead first product), not alone.

        There is a competitor from AbbVie on the market but not even close as good as the newer Harvoni, which has a $95,000 price tag for the 12 weeks treatment.

        I do have a small shareholding in AbbVie left from last year failed “special situation”.

    3. Hi John, In your criteria :-

      “Has failed to grow its revenues, earnings and dividends more than 50% of the time over the last ten years”

      Maybe you have some numbers for 10 years, but in the last 5 indeed including the projections for this year taking it to six, GSK’s revenue will have declined from £27.3Bn in 2011 to £24.8Bn or almost a 10% decline.

      In the same six years the earnings have declined from 114p to 84p — or a collapse by almost 27%

      And for the dividend — has increased artificially at the expense of dividend cover both by earnings and cash flow.

      I think this elevates the risk in comparison from of another 4 earlier years included to make up the 10 year average, simply because of the speed of the decline in the last 6 years.
      On balance I think Andrew Witty is correct in the statement that GSK is better as an integrated vaccines, pharmaceutical and consumer health care mix and not to be split up as the likes of Neil Woodford and his colleagues in the bank sector who are priming the market and the media to create hysteria and push for a high fee paying set of transactions in dividing the company into three.

      Of the two UK pharma biggies, GSK, for the above reasons, looks a better balance of risk than AZN, which looks very high risk right now. I sold AZN in the high 40’s in the firm knowledge that in some miracle of wonders there is another acquisition will come to pass, or a wonder drug is found, I will lose some upside, but the potential downside is enormous — possible a loss of 50% on the share price and a slashing of the dividend.

      Statistically 7% of a drug pipeline is successful in commercial release. Unfortunately commercial release these days have seen drugs no longer being blockbusters, but with revenues that are much lower than the likes of Nexium or Seroquel historically.

      I still hold GSK, but with some trepidation, as this has been a poorly managed business for some time. It’s possible Andrew Witty will not survive, but a change in management won’t solve the looming loss of further revenue in the pharmaceuticals sector for patent losses on Avodart GSK’s treatment for benign prostatic hyperplasia (BPH) in men. Others are set to follow.

      GSK is relatively high risk from a dividend / capital fall perspective unless it produces some high earning new drugs.


      1. Hi LR, it’s likely that next year Glaxo will break that 50% revenue/earnings/dividend rule. Also, I have another rule of thumb which I forgot to mention in the article, which is that I want a company to have kept pace with inflation (estimated at 2%) over the last ten years. Glaxo currently fails that test as its average annualised growth across revenues, earnings and dividends is just 0.4%.

        Although I hold Glaxo I’m not entirely sure I would buy it at the moment. It would be a bit of a leap into a highly uncertain situation, but that low price and high yield are like honey to a Honey Badger.

      2. John, One additional possible positive for GSK is that it has offloaded the bulk of it’s “old approach” oncology business. This might turn out to be a smart move given today’s announcement about the applied immunology cure for cancer. Admittedly it’s on a small sample of patient’s – but the pharmaceutical industry has never seen results like this – they are truly astonishing.
        The other aspect, is that it is a “cure” and not a “treatment” — Treatments offer repeat revenue, cures don’t.

        From a philanthropic perspectic, the cure is obviously desriable in preference. From a pharma business perspective it could be the end of the profit stream for oncology disciplines — and that’s potentially across the whole industry — perhaps another reason not to be caught out with AZN.

      3. Yes and another argument for diversification, although it’s hard to argue that curing cancer is a bad thing!

  2. GSK can’t really hold the governments for ransom.they have lost their most of the drug patents and holding their respiratory products sale by using device patents.The DOH has given a heavier push for savings and that can be achieved only by moving these products to generic prescribing.The picture will be clear by October.
    The next target of DOH will be insulin manufacturers as they are using the same device technique to sell their products at inflated cost.The insulin cartridges are lot cheaper than pre-filled disposable pens in India & other countries but in Europe the manufacturers charge same amount whether it is disposable pen or cartridge.Once DOH pushes for cheaper generic insulin cartridges then shares will drop further .

    1. Hi indigo, you’ve made some valid points there. The patent cliff and spiralling government health costs are definitely areas of concern. These are of course some of the underlying reasons for the 6% yield.

      I don’t really have much to add other than that I’m sure there are thousands of extraordinarily intelligent people within the company working hard to overcome those very issues.

    1. Hi Andrew, I would generally agree with Smith; I think that they are certainly trying to paint a positive picture with their focus on core earnings. Personally I use “normalised” earnings which are a fixed calculation of “adjusted” or “core” earnings, i.e. the same for all companies rather than ad-hoc.

      Looking at the normalised earnings paints a more negative picture than core earnings for Glaxo, where earnings have been gyrating on a slightly downward path for many years. At the same time the dividend continued to grow.

      Also, free cash hasn’t covered Glaxo’s dividend for a while so it definitely has some major issues with sustaining the dividend. I would say it has perhaps another couple of years to get things sorted otherwise there probably will be a dividend cut of some sort, although that isn’t necessarily the end of the world.

  3. Interesting. Thank you both. I like Terry Smith’s take on big pharma:—why-bother-cooking-the-books-if-no-one-reads-them

    On consideration of this (and a reading of the graph) I took useful profits on AZN in October.and, as an interested onlooker, I did not enjoy the roller-coaster at better prices during the next 3 or 4 months. Now, however, I could buy-in at a price below my selling price. Terry Smith (and others) seem to be saying that when “exceptionals” become regular they are “real” costs. We can take account of this and still persuade ourselves to buy these businesses – but now we read of the GSK shenanigans and a £37m fine for illegally stifling a cheap rival drug. Oh dear!

    Terry Smith has also said that he does not invest in banks because he understands them. I wish I’d acted on that.

    1. Hi Alan, yes as I said to Andrew I like Smith’s take on Big Pharma although that doesn’t mean I won’t invest in them as my approach is much more value oriented than his.

      There do seem to be a few too many underhand goings on at Glaxo, despite recent efforts to clean things up. It’s a shame but these things are almost inevitable in large internationally diverse companies operating in highly competitive markets.

      As for banks the only one I own is Standard Chartered, which is having its own problems. I have since tightened up my rules for investing in banks and none of the major banks meet my standards now, including Standard Chartered.

  4. The market is still pricing these companies highly. The investors discount future earnings from possible new patents. I have done this for a while, expecting that the billions invested in R&D would one day pay off.

    So far nothing serious has resulted as a result of the huge funds invested, but it could happen. The last resort now it M&A and this sector was the sector with the highest M&A in the last two years. When the M&A investment bankers steps in, I usually like to step out.

    As a result I decided not to bet on this anymore. Terry Smith has a nice say “I do not invest in companies that may win, I invest in companies that have already won.” It certainly makes sense and it is a simple explanation why Warren Buffet bought Heintz 🙂

    Two years ago I invested in Gilead after they got a new patent. It is a lot easier to calculate and discount the value of an existing stream of income which increases nicely.

    Investment in pharma companies used to be easy, you understand the return of the investment (ROCE) and the life of an asset (in this case a patent) which provides the return. It does not get simpler than that.

    However, as Terry Smith said it, in the last few years they made it very difficult for investors, they used a lot of “strange accounting”. One of the simple rules of investing is to invest in your circle of competence and it something you understand. Nowadays it is harder to understand this industry.

    1. Hi Eugen, I couldn’t agree more. I think even in the “good old days” of easier valuations and less unusual accounting, I still think understanding these companies was very hard. It’s all well and good looking at long-term almost guaranteed cash flows from blockbuster drugs, but more important than that is R&D investment and the pipeline. It was too easy to bask in the warmth of dependable cash flows in the past, and massive underinvestment in R&D is why Glaxo and Astra (which I also own a slice of) are where they are now.

      Whether their futures are bright or not, there will be many interesting lessons to learn, for management and investors alike.

    2. Eugen,

      Terry is undoutedly a smart individual, however, what Terry says and what he does can sometimes differ. He said in his article that highlighted the core/non core aspect of pharma earnings reporting, that he didn’t invest in pharma.
      Yet — yet yet yet — in his top 10 of his 26-28 holdings, Johnson & Johnson features. Not only does it feature, but it was nowhere in his main stream portflio even months ago, so he’s recently bigged up on it.

      Johnson and Johnson’s pharmaceutical business dwarf’s it’s next nearest rival, Pfizer.

      Fund managers eh!! — Don’tcha just love em?

      1. OK I’m going mad now, even replying to my own posting.

        John, on the fund manager thing, it would be great to post on your blog a comparison with the top 5 fund managers and look at possible correlation between their top 10 holdings and any correlation between their style of investing.
        This might be useful in terms of finding any synergy between the value approach and who seems to be consistently winning.
        I’m thinking of Woodford (although I’m highly sceptical on his fund with 100 holdings); Nick Train (seems consistently successful); Terry Smith — and I can’t think who would be a good other two to make the 5.

        Sorry John, you’ve probably got enough to do with your own fund, running the family and keeping the blog active. Just a thought!!


      2. Citywire used to do something like that, with about 5 fund managers and their holdings cross correlated in a table. Just had a look but couldn’t find it so perhaps it’s gone. What you suggest is interesting, so I’ll put it on the “article ideas” list and we’ll see if it ever gets written!

  5. GSK has been on my watch list for years, mostly because of the dividend. Through all that time, the price hasn’t moved a great deal. It almost acts like an investment grade bond rather than a share in a commercial entity. Obviously re-ratings can happen any time, even after 5-10 years of stagnation. Look at MSFT’s sudden change in share price momentum in 2012.

    But re-ratings can be up or down, and I can’t see a lot of reason for an upwards re-rating lately. So I think I’ll still just be watching GSK from a distance, and not really feeling like I’m missing out on much. As opposed to AZN, which I watched at 2,500 and waited and have regretted since that day!

    1. Hi Niall, yes I agree, a lot of people think of it as a bond proxy, or at least they used to until the patent cliff reared its head. I own both GSK and AZN so of course I’m waiting for something to drive a re-rating of both, but as you say whether or not it materialises is another matter.

      At some point though the bullet has to be bitten, otherwise the cash will sit festering with the near-zero percent return that most stockbroker cash accounts give.

      1. I think the major re-rating for AZN has happened already. The culmination of the pessimism seemed to be in 2012. With the yield in the mid 4% range, it still seems to be priced somewhat pessimistically. So I suppose there is still room for further re-rating, perhaps a max upside of 20%-30% based on that yield. But thinking of your future returns bands graph for the FTSE, I think AZN’s approaching close to the middle of the bands.

        Of course, I’m an expert and I know everything about AZN, as proved by my not buying them in 2012. So everyone should definitely take everything I say about them as gospel. Or not.

      2. Hi Niall, I would tend to agree. Although I own AZN it’s not super attractive, but the yield is a wee bit above average and IF the pipeline comes through then growth could also return. But it’s a big IF and there is a lot of uncertainty in how the future will unfold.

        It certainly isn’t a company I would want to bet heavily on, but I’m happy to have a few percent invested in it.

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