Should I Pile Into Neil Woodford Picks GlaxoSmithKline plc, British American Tobacco plc And BT Group plc?

Why I’m tempted to get defensive alongside Neil Woodford and consider GlaxoSmithKline plc (LON: GSK), British American Tobacco plc (LON: BATS) and BT Group plc (LON: BT.A).

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Well-known outperforming fund manager Neil Woodford built his portfolio on the expectation that it will receive little help from macroeconomic trends, he reckons.

If the firms he’s holding are to deliver on investor total returns, they need to stand on their own merits and achieve advances by hard-earned business growth, operational efficiency, and effective execution of their strategies.

Today, I’m looking at three firms featured in the top ten largest holdings of the CF Woodford Equity Income Fund: GlaxoSmithKline (LSE: GSK), British American Tobacco (LSE: BATS) and BT Group (LSE: BT-A).

A defensive sector

Many consider the pharmaceutical sector capable of producing defensive investment opportunities because demand for drugs and medicines continues, and even grows, whatever the economic weather. That means that a pharmaceutical giant such as GlaxoSmithKline doesn’t tend to see its profits and share price waggle up and down too much, unlike cyclicals such as banking firms and mining companies.

Cash flow tends to remain steady and robust at GlaxoSmithKline, which means that the directors can keep up dividend payments and raise them in line with earnings’ growth. That’s probably why Neil Woodford sticks with the pharmaceuticals through thick and thin. He wasn’t put off holding GlaxoSmithKline Shares during the firm’s patent-cliff challenges of the last few years, for example.

The good news is that GlaxoSmithKline’s shares are down around 27% from the highs they reached during 2013 and look better value than they did back then. At today’s 1298p share price, the forward price-to-earnings (P/E) ratio runs at just over 15 for 2016 and City analysts expect earnings to bounce back 12% that year. That valuation doesn’t seem too demanding when considered with the 6.3% forward dividend yield, even though earnings will likely only cover that payout once.

If GlaxoSmithKline gets its earnings back on track with a new generation of blockbuster patent-protected drugs, today’s price for the shares will be attractive.

A different kind of drug

The tobacco sector has many similarities with the pharmaceutical sector. Like demand for medical drugs designed to make us feel better, demand for addictive tobacco products tends to be reliable from those that use them. As such, a firm such as British American Tobacco tends to generate steady cash flow and pay reliable dividends just like the pharmaceuticals do.

That’s probably why Neil Woodford sticks with the tobacco and cigarette suppliers. In many ways, the sector is as defensive as the pharmaceutical sector, if not more so given the addictive nature of the product.

For a long time the structural decline of the tobacco industry worried me, but British American Tobacco kept raising its margins, winning market share from other players, and buying back its own shares to drive up earnings- and dividend-per-share figures. The shares advanced by more than 200% over the last decade.

Last year the share buyback programme halted and the firm is putting money into buying out competitors, which could end up being an equally effective strategy to enhance returns for shareholders.

At today’s share price of 3600p, the forward P/E ratio sits around 16 for 2016 with City analysts expecting earnings to advance 7% that year. The dividend yield runs at 4.5% and those improved earnings should cover the payout almost 1.4 times. As usual, British American Tobacco doesn’t look cheap.

Cyclical and growing

Back in March 2009, we could’ve picked up BT Group shares for about 77p. In the wake of the credit crunch, the shares plunged. Back then, investors must have believed the firm’s business to be cyclical.

There is a big element of cyclicality to BT’s business. If the economy tanks there’ll be less demand for telecom and data services as businesses and households belt-tighten. However, from those lows in 2009 BT’s share price has increased by almost 450%, but we are seeing more than just a cyclical bounce-back, I reckon.

BT made great strides growing its broadband and fibre-optic internet services over the period as well as bearing down on costs to enhance profits. To be holding on now, Neil Woodford probably anticipates further growth from the firm.

At today’s 420p share price, BT trades on a forward P/E rating of almost 13. City analysts following the firm expect earnings to grow 7% for the 2016 trading year, which means earnings will cover the dividend twice, generating a yield of 3.7%.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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