Tuesday, August 12, 2014

GlaxoSmithKline - Stout Yield Worth the Risks?

GlaxoSmithKline is the second stock that I added to the Wide Moat Dividend (WMD) portfolio. The positives are pretty clear - a 5.6% yield really stands out in this yield parched world. All the better when it comes from a defensive company like Glaxo and sells for a discount to the market, Glaxo's trailing P/E is 14. With a decent price and a five year average ROE at 58%, this is a stock that Joel Greenblatt would love, and in facts its one of his holdings.

Still as Joel Greenblatt is the first to point out, you do not make it through his magic formula screen when everything is rosy. There has to be a lot of hair on any company that can those generate those ROEs and still sell so cheaply - Glaxo faces a number of near and mid term challenges.

As great as the yield, P/E and ROE metrics are, there are troubling numbers, too. Glaxo's payout ratio is 81% and its Debt/Equity is 2.4. There is not a lot of room to maneuver here if things go poorly. However there are some factors that balance out some of the negative.

The stock price was hit when Glaxo recently lowered guidance and stopped buybacks. However, for the purposes of the WMD portfolio I care more about the dividend than buybacks. On dividends, the the focus of Glaxo management shines through, they raised the dividend 6%.

I use a simple 5+5 metric for the WMD portfolio, the yield plus dividend growth should exceed ten percentage points. With a 5.6% yield plus a 6.6% five year annualized dividend growth rate, Glaxo earns a 12.2. Things are not perfect at Glaxo, but prioritizing dividends over buybacks is a good tradeoff here in my view.

The list of challenges facing Glaxo is not short, however that is what gets you a price like we see today. There are not guarantees, but management's priorities appear to be in order, favoring shareholders. Despite its current standing as sector whipping boy, Neil Woodford views Glaxo's troubles as temporary, has Glaxo as his fund's second largest holding, around 7% of the fund. Woodford's comments could be construed as talking his book until you realize that he has purchased his Glaxo shares in the last two months.

There is a lot to do for Glaxo to be successful, like any pharma company they have to continue to roll out successful platforms, in Glaxo's case its respiratory. The company is adding less glamorous areas like vaccines and consumer health (which will soon represent more than half Glaxo's income). One analyst derided them as "The market is changing around them, and there's a sense Glaxo is the granddad stuck in the corner." I have no problem with boring, actually that sounds favorable to me.

Its not a no brainer investment, despite the gaudy price, yield and quality metrics. While Glaxo's risks are real, at a 5.6% yield, investors have a chance to earn a stout income as the process unfolds.

No comments:

Post a Comment