GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) has been a core part of my income portfolio for some time, but I’m beginning to wonder whether its management’s focus on keeping shareholders happy in the short term is working against shareholders’ long-term interests.
I’ve recently put my Glaxo shareholding under review, for three reasons.
1. Debt
GlaxoSmithKline has a staggering level of debt. At the last count, the pharmaceutical firm’s net debt was £15.7 billion, which equates to net gearing of 245%.
Glaxo paid interest of £361m during the first half of this year, which equates to an annualised interest rate of around 4.6% on its entire net debt. This isn’t high — Glaxo has a good credit rating — but I’m still not keen, as long-term interest rates can only rise from current low levels.
2. Share buybacks
One reason Glaxo’s net debt isn’t falling is that it is planning to spend £1-2 billion on buying back its own shares this year.
I think this is a short-sighted move that could soon look expensive if interest rates rise and Glaxo’s share price continues to fall. The buyback programme has been carried out while Glaxo’s share price has been at near-record levels, and I suspect its main purpose is to boost the firm’s flagging earnings per share.
3. Stagnation
The subject of flagging earnings brings me to the final reason I’m considering selling my Glaxo shares. Stagnation is never appealing, although when compensated for by a generous yield, it can be worthwhile.
However, in Glaxo’s case, I’m not sure. Glaxo’s dividends have not been covered by free cash flow for the last two years, and dividend cover has only been an average of 1.3 times earnings over the last five years.
Sell Glaxo?
Glaxo’s current programme of divestments is a positive step that may help to strengthen its balance sheet, but I think that the firm needs to take more decisive action by scrapping buybacks and freezing the dividend, while it reduces its gearing, before borrowing costs start to rise.
Although Glaxo’s defensive, world-class business means that its debt is unlikely to drive the company into the ground, I believe it could still become a burden that saps earnings and dividend growth in future years.
Glaxo’s third-quarter results are due on October 23, so I’m going to hang fire until then, but Glaxo will remain on my sell list for now.
