Unfortunately, even our biggest companies aren’t immune to cutting their dividends — either partially or completely — if they fall on hard times. Tesco, Centrica and Rolls-Royce have all taken a knife to their payouts over recent years. Thanks to very different problems, pharmaceuticals giant GlaxoSmithKline (LSE: GSK) and tobacco mammoth Imperial Brands (LSE: IMB) could be next.
But which looks more likely to disappoint investors?
Pipeline problems
Despite registering a return to earnings growth in its three divisions in 2016 and being a major beneficiary of the pound’s recent weakness, the future for Glaxo’s chunky payout still looks precarious.
Arguably, the company’s biggest problem remains its drug pipeline. Put simply, a loss of lucrative patents has meant that new blockbuster treatments need to be found. Aside from the significant research and development costs, this can take time. Nevertheless, even Glaxo’s most patient holders might be inclined to say this is already taking a lot longer than expected.
While the company’s less profitable consumer healthcare division can take the strain for a while, there may come a point at which Glaxo is required to make the sort of sacrifice many investors wouldn’t consider from a business with such defensive qualities.
This is, of course, partly why Neil Woodford — once such a big fan of the company — recently disposed of his entire holding. In addition to fearing for the dividend, Woodford became increasingly frustrated at management’s refusal to consider splitting Glaxo into more specialised units.
Given that its 5.3% yield still isn’t covered by profits and dividend growth has been ruled out by new CEO Emma Walmsley until this situation improves, Glaxo’s status as a go-to destination for income hunters is in serious jeopardy.
Out of puff?
While some investors may feel uncomfortable holding shares in companies whose products can be both addictive and disease-causing, it’s hard to deny that tobacco stocks have been some of the most rewarding to buy and hold in recent times. Just ask the aforementioned star fund manager.
Trouble is, Imperial Brands — and its FTSE 100 peer British American Tobacco — now face a challenge in the form of the US Food and Drug Administration’s (FDA) plans to lower nicotine levels in cigarettes to ‘non-addictive’ levels. For companies that depend on a habit being maintained, that’s somewhat problematic. An eventual squeeze on profits could put pressure on Imperial to reduce its much-cherished dividend payouts (forecast 5.3% yield for 2017).
But here’s why I think Imperial’s situation is so different from Glaxo’s. Whereas the latter’s predicament is easy to understand, the former’s situation benefits from the considerable uncertainty over how the recent announcement will work in practice. What would constitute ‘non-addictive levels’ of nicotine anyway?
With many known unknowns, no target date for the implementation of these rules and the possibility that more of Imperial’s customers will simply shift from cigarettes to using its alternative products, I think the shares are a solid HOLD for now.
Bottom line
Will Glaxo and Imperial be forced to make a cut? Nothing is guaranteed. That said, if I were a holder of both, I’d be more concerned by the fact that Glaxo still faces an uphill battle to bring its next blockbuster drug to market sooner rather than later. Of the two, my money’s on Imperial’s dividend to survive unscathed.
