Why GlaxoSmithKline plc And Imperial Tobacco Group PLC Are Perfect Partners For Income Investors

GlaxoSmithKline plc (LON:GSK) and Imperial Tobacco Group PLC (LON:IMT) form a potent income combo.

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Dividend disappointments have come thick and fast in recent years. And even though recovery from the financial crisis and recession rolls on, income investors continue to see the dividend axe fall with monotonous regularity.

Already this year, we’ve seen Tesco decide not to pay a final dividend and give no timescale for when payouts might resume, Centrica rebase its dividend 30% lower, Severn Trent announce a 5% rebase and a reduced growth commitment, Sainsbury’s deliver a dividend 24% below last year’s level, Morrisons warn of a cut of up to 63% for the coming year … and so the list goes on.

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GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) hasn’t cut its dividend, but has recently dampened shareholders’ previous expectations of the level of cash returns in the pipeline. The company said it anticipates pegging the annual dividend at 80p a share for each of the next three years (2015-17). Management also said that a previously-guided c. 80p a share capital return this year will be dropped and replaced by a 20p special dividend.

On the positive side, retaining more cash within the business — while the company gets through a period of expiring patents — is a reassurance for investors who had been getting jittery about debt and low dividend cover. We now have good visibility on what income we can reasonably expect (affordability now looks much better) for the next three years.

While a static dividend isn’t ideal for income investors, Glaxo’s yield is high. Furthermore, I think pairing the pharma giant with Imperial Tobacco (LSE: IMT) (NASDAQOTH: ITYBY.US) — which has a commitment to grow dividends by at least 10% a year “over the medium term” — should provide income seekers with a powerful combination of a well-above-average starting yield and steady, above-inflation annual income growth for the next three years … and, hopefully, beyond.

The table below shows dividend expectations for the next three years, based on Glaxo’s guidance and Imperial’s policy of growth of at least 10% a year (I’ve used 10% in the calculations, so the payouts could be higher).

Company 2015 2016 2017
Glaxo 80p* + 20p special 80p 80p
Imperial 140.9p** 155.0p 170.5p

* The ex-dividend date for Glaxo’s first quarterly dividend of this year is 14 May.

** The ex-dividend date for Imperial’s first quarterly dividend of this year is 28 May.

So, let’s have a look at how the above would translate into starting yield and annual growth for anyone investing before 14 May (Glaxo’s first ex-dividend date), based on the share prices of the two companies at the time of writing.

Company Share price 2015 yield 2016 yield 2017 yield
Glaxo 1,477p 5.42% (6.77% including special) 5.42% 5.42%
Imperial 3,296p 4.27% 4.70% 5.17%
Combined n/a 4.85% (5.52% including special) 5.06% 5.30%

This looks an attractive income proposition from two defensive businesses; and one would hope that after three years Glaxo would be in a position to start increasing dividends again.

Of course income from shares is never 100% guaranteed, but I think this equity pairing could be well worth considering as an addition to a portfolio of income-generating assets.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline and Centrica. The Motley Fool owns shares in Tesco. 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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