GSK
Declining sales and earnings have forced GlaxoSmithKline (LSE: GSK) to freeze its dividend at 80p per share until 2017. As profitability for the company has not recovered as quickly as previously anticipated, GSK has been unable to fund its dividend entirely through free cash flow. It has also had to cut back on its plans to return shareholders with £4 billion of the net proceeds from the sale of its oncology business to Novartis. It now plans to return just £1 billion to shareholders, through a special dividend, which would be paid alongside its usual Q4 2015 ordinary dividend.
Declining earnings and sales has been a constant theme over recent years, as the sales of new drugs have not been able to offset the loss of sales from blockbuster drugs that have lost patent expiration. Sales of Advair, GSK’s best-selling respiratory drug, continued to decline in the second quarter of 2015, having fallen 17% to £484 million.
Analysts currently expect adjusted EPS will fall 21% this year, to 75.5p, which means its ordinary dividend would no longer be fully covered by earnings. Earnings is projected to recover 12% in the following year to 84.5 pence, but that only leaves its dividend cover ratio at 1.06x.
But, although dividend cover is weak in the near term, it will not likely stay that way. GSK has a pipeline of 40 new drugs, which should mean the company would be able to sustain modest growth in earnings over the next few years. This should mean GSK’s yield of 6.1% is not only sustainable, but likely to grow further in the longer term.
Vodafone
Weak trading conditions has also meant Vodafone (LSE: VOD) has not been able to fund its dividends through free cash flows for a number of years now, but that does not mean its dividends are unsustainable. Having sold its US joint venture with Verizon, Vodafone has net debt to EBITDA of just 1.9x, which is significantly lower than many of its peers in Europe and North America.
Vodafone is showing signs that trading conditions are beginning to turn around, with organic group service revenue in the quarter to 30 June growing 0.8%, its fastest rate for almost three years. On top of this, it has also been making acquisitions into the European broadband and paid TV market, allowing it to bundle various services together, and this should help it to reduce customer churn rates and develop stronger pricing power over its customers.
Analysts expect Vodafone’s underlying EPS will fall 6% this year, to 5.2p, before recovering 20% in the following year, to 6.2p. Shares in Vodafone have a lower prospective dividend than shares in GSK, at 5.6%, but Vodafone is expected to continue to grow its dividend by about 2% over the next two years.
Berkeley Group
Although housebuilding shares are not generally regarded as income stocks because of their cyclical nature, the growing profitability of the sector has meant free cash flow is often well in excess of its development capital needs. And, this has enabled many of them to pay some very handsome dividends.
London housebuilder Berkeley Group (LSE: BKG) has been benefiting from an increase in new home completions, causing its earnings to grow 44.6% in its 2014/5 financial year. Despite the recent turmoil in global stock markets and the anticipation of higher interest rates in the UK, Berkeley Group’s outlook remains very attractive.
Analysts have increased their forecasts on the housebuilder’s earnings, and they now expect underlying EPS will be 278.1p, which implies a forward P/E of just 12.2. In addition, Berkeley intends to pay 433p in dividends per share over the next three years, which implies a prospective dividend yield of 4.3%.
