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Concerns over future dividends offer a good buying opportunity in GlaxoSmithKline

By Gary Newman | Saturday 2 December 2017

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

The big pharmaceutical companies have traditionally been a fairly safe bet for a steady source of income over the years, and through the peaks and troughs in the markets.

I still see that as being very much the case, as despite the risks of potential problems with individual drugs, overall these companies will always tend to perform well and are diversified enough to overcome any short term problems.

I would argue that is very much the case currently with GlaxoSmithKline (GSK), and not only does it offer a good source of income through its dividends, but now that it is trading at close to the lowest level that it has been in the past five years, at a price of just 1290p, it also offers plenty of opportunity for capital growth.

During the past month or so the share price has lost around 15% of its value, having been trading steadily around the 1520p level, and this would largely appear to be as a result of uncertainty over future growth in some major areas of the business, plus some concerns over dividends.

The company is still growing, but over the next few years that may not continue at as fast a rate as had been hoped, and by far the largest area where revenue is generated, at over 50% – pharmaceuticals – only grew at 2%, as per the last set of quarterly results.

The recent star for Glaxo has been its majority controlled ViiV business (Pfizer also own a share) which specialises in HIV treatments, and it recently received FDA approval for a two-drug, one-pill drug called Juluca.

A potential problem for Glaxo though is that competitor Gilead has re-entered this $22 billion market, and there are concerns as to just how much business the company will lose as a result of this. Given that ViiV is a large contributor to revenue, and the bottom line, it would have a noticeable impact on the performance of the company.

Late-stage studies are said to show that Gilead’s drug exhibits a similar level of effectiveness, so a lot will come down to overall market share, and I think that the negative scenario for Glaxo in this respect has largely been priced in already. Although it would seem inevitable that revenue growth in this area will be affected, given that there previously wasn’t any competition in this specific market from Gilead.

The current dividend yield stands at around 6%, with a total of 80p being paid out, and that is being maintained for 2018. But in recent times that has been paid out regardless of free cash flow, and as a result of this policy, investment in future growth has often led to an increase in the level of debt.

That sort of policy would appear to be unsustainable longer term, and so the company also announced that from 2019 onwards, dividends would be determined by quarterly free cash flows, and based on the current figures that would mean cuts.

It was this talk of possible reductions in the future dividends which I believe really hit the share price hard, especially when taken alongside the ViiV potential slowdown in growth – plus some of the other drugs which it has previously relied upon have been doing less well in recent times.

But the consensus amongst analysts points to the company being able to increase cash flow by 2019 to a level that would support the dividend at least at its current level, and with potential for increases.

On that basis, and barring any unexpected negative news relating to the ViiV side of the business, I can’t see the share price going much lower and feel that it represents good long term value at this level. For anyone looking for a fairly safe FTSE100 longer term investment that will also generate a decent amount of income, I think you will be hard-pushed to find a better option than shares in GlaxoSmithKline.   


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