At the end of last week, star fund manager Neil Woodford caused a stir when he announced that funds under his stewardship had dumped their holdings of GlaxoSmithKline (LSE: GSK).
In a blog post published on Friday titled Glexit, Woodford explained his decision to turn his back on this income champion. In summary, the move was based on Glaxo’s inability to create value for shareholders. He also raised concerns about the sustainability of earnings growth, which is putting the dividend at risk.
This isn’t the first time Woodford has criticised one of the market’s most respected dividend champions. Earlier this year he proclaimed that BP and Shell are “liquidating themselves” as they sell assets to fund dividend distributions and BT has also come under fire due to its weak balance sheet.
The big question is, should investors now copy Woodford and dump their Glaxo holdings? Well, this is a difficult question to answer as it looks as if Glaxo is currently turning a corner.
Value creation
It is difficult to disagree with Woodford’s reasoning that Glaxo has struggled to create value for shareholders during the past few years.
Over the past five years, shares in the company have gone almost nowhere rising only 16% excluding dividends since mid-2012. Over the same period, the FTSE 100 has gained 34%. Glaxo has struggled as the company has lost the exclusive manufacturing rights to some of its most lucrative treatments. These headwinds have held the company back, but management has been working hard to refocus the group. New therapies are finally starting to come through the pipeline and Glaxo’s $20bn asset swap with peer Novartis has given it a leading position in the market for consumer pharmaceuticals.
Break-up needed?
Woodford has long argued that Glaxo should break itself up, which would unlock value as well as allowing management to spin-off underperforming divisions. A lack of action by management on this front is cited as being one of the reasons why he has decided to sell, but it’s not clear if such a strategy would help the business. Glaxo’s biggest strength is its diversification and by breaking the business up, the company would lose this crucial advantage. Woodford also argues that without such a strategy Glaxo’s dividend is in jeopardy. Maybe so, but if the business broke up, some parts would fare better than others, and the lack of diversification, as well as higher costs, may mean that while value is created in the short term, over the long term investors could lose out.
Future uncertain
Having said all of the above, it is almost impossible to tell what the future holds for Glaxo and the company’s dividend. Still, over the past five years management has proven itself by reigniting earnings growth. Overall group sales grew by 5% year-on-year at constant exchange rates for the first quarter and based on current City forecasts, this year Glaxo’s earnings are expected to cover the company’s per-share dividend payout by 1.4 times.
All in all, while Neil Woodford might have his doubts about the sustainability of the 5.2% dividend yield, it does not look as if now is the time to sell. Glaxo’s sales growth is just starting to pick up, and the company’s outlook is brighter than it has been for several years.
