GlaxoSmithKline (LSE: GSK) is one of the five biggest companies in the FTSE 100 and pays generous dividends. As such, it’s long been a core holding in the portfolios of many investors.
However, its debt has increased dramatically over the last decade or two. Could this now pose a threat to its share price and dividend?
Ballooning debt
Back in the mid-2000s, GSK had net debt of less than £2bn. By the end of the decade this had risen to £9.4bn. Currently, it stands at £25.2bn.
Despite the ballooning debt, the company has continued to pay shareholders an 80p annual dividend since 2014. This payout amounts to nearly £4bn a year. Clearly, borrowing more and more money in order to maintain a dividend can’t continue indefinitely.
Prudent peers
In its annual results, released last week, GSK reported shareholders’ equity of £12m against the aforementioned net debt of £25.2m. This gives net gearing of 210% (net debt divided by shareholders’ equity multiplied by 100). Put another way, for every £1 of shareholders’ equity, GSK has £2.10 of debt.
This is very high compared with its global big pharma peers. Johnson & Johnson, Novartis, Roche, Pfizer and Sanofi all had net gearing of below 50% at their last reported year ends. I’d describe this as a prudent level of gearing. GSK hasn’t been in this club for over a decade.
Heading in the right direction
The good news for the Footsie firm’s shareholders is that while current net gearing of 210% is high, it’s come down from 491% at the end of 2018 when shareholders’ equity was £4.4bn against net debt of £21.6bn. The year before that (2017) shareholders’ equity was minus £68m against net debt of £13.2bn, meaning gearing was off the scale.
During these years, some analysts and investors feared the company would cut the dividend. Indeed, some urged it to do so. They argued GSK should allocate more capital to refreshing its pharmaceuticals pipeline.
However, management stuck to its guns. It was able to do this because lenders remained supportive. With net gearing now falling, and other ratios — such as net debt/EBITDA and interest cover — also heading in the right direction, GSK’s dividend looks more secure.
Buy, sell or hold?
I’m confident GSK’s business and balance sheet are on a stronger footing. But would I buy the stock today?
My Motley Fool colleague Michael Baxter described the company’s latest results as lacklustre. That’s a fair assessment, in my opinion. Earnings per share (EPS) of 123.9p came in slightly below a company-compiled consensus of 125p. Furthermore, for 2020, management has guided on a decline in EPS of between 1% and 4%.
On the face of it, this doesn’t seem particularly inspiring. However, I think the prospects for the business and the current valuation of the stock are attractive.
Management is increasing R&D investment in biopharma, and preparing its consumer healthcare business for a future demerger. I think its strategy has every prospect of creating significant value for buyers of the shares at a current price of 1,700p.
Trading at around 14 times forecast 2020 EPS of 119p-123p, and with the 80p dividend giving a yield of 4.7%, I rate the stock a ‘buy’.
