Personal Finance

Is GlaxoSmithKline's Dividend Sustainable?

Gsk Dividend

British drugmaker GlaxoSmithKline plc (NYSE: GSK) is one of the top-yielding dividend stocks in the medical sector. Company management has committed to paying a quarterly dividend through 2017 that amounts to a yield of 4.7% at today's exchange rate. A rich payout like that will attract the attention of dividend investors -- but how safe is that return after this year? Probably not safe enough for many conservative investors.

Gsk Dividend

Data source: GlaxoSmithKline plc. Chart by author.

As we can see, even if there had been no restructuring expenses, free cash flow still would not have covered the dividend payout in any quarter except the most recent one. Over this year and a half, Glaxo has paid out $3.3 billion more in ordinary dividends than it has generated in free cash flow. This deficit has been absorbed by decreasing cash and increasing debt. Net debt -- debt minus cash and marketable securities -- increased $4.8 billion from Q2 2015 to present.

The company had enough cash from the sale of its oncology business to Novartis to easily handle these demands without endangering its credit rating, but clearly the track record casts doubt on the company's ability to maintain the payout over the long term.

The picture is improving

Fortunately there is some good news for shareholders. It's clear from the above chart that the situation in the last two quarters has drastically improved. There are several reasons. One was outside the company's control: exchange rates. The CFO reported last quarter that half of the improvement in free cash flow in the first nine months of 2016 compared with 2015 was due to the decline in the British pound. The benefit to the business is a result of the fact that most of the company's costs are in Britain, whereas most of its sales are outside the country.

But good things are also happening as the restructuring is taking hold . So far, over $3 billion in annual cost savings have been implemented. Better still, the company's growth profile improved with the restructuring, and those decisions are beginning to pay off. The last two quarters may be more indicative of the company's future than the prior ones have been.

Some risks remain

Still, conservative investors should beware. Two quarters of good cash generation are not much of a track record. If the pound stays depressed, the currency benefits should continue, but any reversal of the pound's decline will also reverse the post-Brexit windfall the company has enjoyed. If the company's blockbuster asthma drug Advair gets hit with generic competition sooner rather than later, a large portion of the drug's sales -- 12% of company revenue in the last nine months -- will be at risk.

And finally, there is some risk in the agreements around Glaxo's joint ventures. The other partners have been granted put options -- that is, they have the right to demand that GSK buy out their shares of the subsidiaries at the value of that stake at the time. These options are carried on the balance sheet as a liability of $12 billion, and that amount could grow if the value of the businesses grows. The company believes this won't happen, and if it does, the purchase could be absorbed by the balance sheet. But it would certainly put a major dent in the company's finances if it did.

All in all, GSK has not yet proven itself as a safe bet as a dividend stock, which is probably why the market hasn't bid its stock price up to a level where the yield is more typical for its cohort. Investors who are willing to take a little more risk and are interested in the growth prospects that are beginning to improve should consider GSK. But conservative investors looking for a safe dividend that is likely to grow over time should look elsewhere.

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Jim Crumly has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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