GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) is a company that I think screams value.
For instance, its free cash flow yield is extremely impressive, being just over 4% at the moment. Of course, higher yields are inevitably available elsewhere, but GlaxoSmithKline continues to spend generously on increasing the size of its balance sheet (thus harming free cash flow in the process) and also tends to trade on a premium to the wider stock market as a result of its relative quality and stability.
So, when those two items are taken into account, a free cash flow yield of over 4% sounds very good indeed.
Furthermore, GlaxoSmithKline remains a financially sound company. Evidence of this can be seen in the substantial headroom it enjoys when making interest payments.
In 2012, GlaxoSmithKline’s interest coverage ratio was 9.2, which means it could have paid the interest owed on its debt for that year 9.2 times with the operating profits it generated.
This is more than adequate and shows that the company has the scope to borrow further, perhaps to fund bolt-on acquisitions or to invest in improved research and development facilities. It also highlights the fact that when interest rates eventually go up, GlaxoSmithKline is unlikely to face significant problems with higher interest payments eating away at operating profit. In my view, this highlights its stability and is a big plus for investors like me.
In addition, I remain convinced that GlaxoSmithKline is capable of increasing its dividends per share by quite some degree. For instance, the company’s payout ratio (the proportion of earnings paid out as a dividend) was two-thirds in 2012. This may, at first, seem reasonable but in my opinion GlaxoSmithKline is a mature company operating in a mature industry and, as such, should be paying out a greater proportion of earnings as dividends.
Certainly, the GlaxoSmithKline of old was a pure play growth stock and a lower payout ratio could be justified. However, today it is in a different situation (where growth rates are far lower) and I believe that a higher payout ratio is justified, which would translate into a higher yield for shareholders.
