GlaxoSmithKline (GSK) has been in my portfolio for many years now. The GSK shares have paid me a dividend four times a year. My dividend yield is over 5 percent. A safe return of 5 percent per year is a decent yield that I’m not complaining about, even though GSK has never increased its payout during all these years. Now, however, it looks like GSK will cut the dividend in the next few years.
GSK had reported quarterly and annual results at the beginning of February. GAAP EPS was in line with expectations at 0.23 GBP. Revenue was even above analysts’ expectations at 8.74 billion GBP. For 2021, GSK expects adjusted EPS to decline between 5-9 percent. Besides, GSK is on schedule concerning the spin-off of the consumer products business. It intends to bring the consumer business into a JV together with Pfizer. The step is expected to deliver 0.7 billion GBP of annual savings by 2022 with improved operating performance (but will also cost around 3 billion USD initially).
The figures for the year as a whole were not bad either. Overall, GSK grew by 3 percent despite COVID-19. Only adjusted EPS fell by 4 percent.
However, management around CEO Emma Walmsley had the following to say during the earnings call regarding the dividend:
We intend to implement a new distribution policy for dividends from 2022, the year of separation into two new companies.
The new policy will ensure we have the right capital structure for each business and the capacity to invest so that we can deliver growth and long-term shareholder value. We expect to implement the new policy from Q1 2022 and that the distribution will be lower than the 80p per share currently paid. The new policy will target progressive dividends informed by appropriate earnings payout ratios through the investment cycle and will be well covered by free cash flow.
We’re very confident in the prospects for the vaccine business beyond the impact of COVID-19, for all the reasons that Emma and Roger have set out, and what we will do in June, we’ll set out in considerable detail those medium-term financial outlooks that inform the top line – our margins, our adjusted EPS, balance sheet structure and the like, and what we will also do in June is set out the key factors that inform the dividend policy and the dividend policy for that new GSK, the new biopharma business.
I think what we’ve been clear today is that we would expect the aggregate distributions for the biopharma business and the consumer healthcare business standalone to be less than they presently are today, but that importantly they have the propensity to grow and to be progressive dividends from that point onwards. We will provide the information that helps everybody to model this through and think about the investment case in the round, not just in the very specific context of a dividend policy, which is principally why we’re not giving you the full detail on that policy today.
The new GSK dividend situation
So we know that shareholders will receive a lower dividend yield from 2022 than they currently do. What we don’t know is the exact height. We also do not know how the dividends will be distributed between the JV with Pfizer and GSK. Analysts expect a cut of almost 20 percent to GBP 0.65 per share.
Based on the current share price, this still corresponds to a dividend of over 5 percent.
Should I sell my GSK shares?
How does an investor deal with a dividend cut? Difficult. At GSK, a dividend cut had been hanging in the air like a sword of Damocles for years.
However, management considered itself committed to the dividend. I think the company realized that the payout had taken away some of the breathing room. Even if a dividend cut hurts, it can be the right decision in the long run. Conversely, I want my companies to build cash flow. If a company doesn’t deliver, then I have no problem selling it.
- The company has more than 20 new product launches planned by 2026; GSK expects that at least 10 of them will reach peak sales of at least 1 billion USD annually
- I don’t want to miss the JV with Pfizer. I think it’s going to be a strong market leader. The GSK consumer business grew by a robust 14 percent in 2020.
- The GSK share price has fallen significantly and is fundamentally extremely undervalued. The current adjusted P/E ratio is 11. Assuming the fair value is based on a conservative adjusted P/E ratio of 14, this results in an annual return of 15 percent based on expected earnings through 2024.
Therefore, my conclusion is: As a shareholder, you share all the successes and all the risks of the company. GSK is still a good company. Management has decided to cut the dividend. That is the way it is now. Besides that, the stock is massively undervalued and offers a lot of fantasies. I will thus not sell. There will be more updates on the JV with Pfizer over the next few months. I will therefore wait and watch the situation.
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