At first glance, pharmaceuticals giant GlaxoSmithKline (LSE: GSK) seems expensive. The stock trades at a price-to-earnings (P/E) ratio of 19 and has a price-to-sales (P/S) ratio of 3. But are appearances deceptive? And with the company returning to growth, maybe valuations aren’t as expensive as they initially seem.
Recent sales figures show revenue growth from new products beginning to more than offset the decline in revenues from older blockbuster respiratory drugs, putting Glaxo back on the sales growth trail. New products currently account for £2bn in annual sales, but this contribution is expected to rise to £6bn by 2018.
City analysts are optimistic too, with earnings forecasts pointing towards a strong rebound this year. Adjusted earnings per share (EPS) are expected to climb 16% this year, with further growth of 6% pencilled-in for 2017. This means its forward P/E is expected to fall to 16.2 and 15.4 by 2016 and 2017, respectively.
Its dividend, which management has frozen at 80p per share annually until the end of 2017, currently yields 5.5%. Dividend cover for GSK fell below the symbolic 1 level in 2015, but with earnings expected to bounce back strongly, investors should have little to worry regarding the sustainability of its dividend. Dividend cover in 2016 and 2017 is expected to rise above 1 and by 2018, the level could rise above 1.2 times.
Strong prospects
BAE Systems (LSE: BA) is benefitting from developments that should boost its business. Rising geopolitical tensions and political unrest in the Middle East have led to increased defence spending globally, and the impact of this has already made its mark on BAE’s recent sales figures. Sales and operating profits in 2015 grew at their fastest paces in five years, up 7.6% and 15.5%, respectively.
The company’s forecast dividend payment of 21.4p per share should be covered by expected earnings of 38.6p per share, which would give it dividend cover of 1.8 times.
With the stock currently trading on a forward P/E of 12.2 and offering a prospective yield of 4.4%, I think this stock is deeply undervalued. That 4.4% doesn’t make it the highest-yielding in the market, but with a low dividend payout ratio and favourable tailwinds for the sector, there’s plenty of scope for dividend growth.
Wild card
My final dividend idea is Amec Foster Wheeler (LSE: AMFW). Its shares have fallen by over 50% over the past 12 months, but I believe it to be an under-appreciated income play.
The firm reassured investors in April, by re-affirming that it expects to see “only slight like-for-like revenue decline, with a reduction in trading margins significantly less than the decline in 2015.”
City analysts expect pre-tax profit for the full year of between £150m and £175m, with adjusted EPS declining by 20%, to 54.5p. But despite the anticipated fall in earnings, Amec shares trade at a very undemanding forward P/E of 8.1. Additionally shares have a prospective yield of 5%, with forecast dividend cover of more than 2.4 times.
There are downside risks though. Energy prices, which have recovered strongly in recent months, could dip again and potentially lead to further cuts in capital spending by the oil & gas industry. In addition, margins could also come under pressure due to weak market conditions and pricing pressures from excess capacity in the industry.
However, I believe these risks are already fully accounted for in its share price.
