How Strong Are GlaxoSmithKline plc’s Dividends?

GlaxoSmithKlineGlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) has been steadily lifting its dividend year-on-year, offering yields of around 5% — there’s 5.1% pencilled in for this year, on a share price of 1,568p.

That’s an attractive yield, especially in low-interest times and when the FTSE 100‘s average annual cash payout amounts to only around 3%.

But look back a few years, and a slightly worrying trend appears — dividend cover is falling.

Falling cover

The 61p dividend paid in 2009 was approximately twice covered by earnings per share. Leaving out the anomalous year of 2010 when major restructuring and legal cost caused bottom-line earnings to slump, by 2011 we saw a 70p dividend covered 1.6 times by earnings. And that continued, with cover dropping to 1.5 times in 2012 and to 1.4 times by 2013.

By 2013, EPS was down 7% from its 2009 figure, yet the dividend had been lifted by 28%.

And cover is set to fall further. Analysts are currently forecasting a 7% fall in EPS this year, yet the dividend looks set to be raised by another 4.5% to lower cover to under 1.3 times. We’ve already seen a 6% rise in the first-quarter dividend, although the firm did make it clear that it enjoyed free cash flow of £0.5bn.

Dividend commitment

And we were told that “GSK’s commitment is to use free cash flow to support increasing dividends, undertake share repurchases or, where returns are more attractive, reinvest in the business, including bolt-on acquisitions“.

Predictions for 2015 look a bit better, with a 10% EPS rise taking cover up a little to 1.35 times — but is that still a little low for comfort?

On top of the dividends, Glaxo is also handing out extra cash in the form of share buybacks — which take the firm’s effective annual cash returns to around the 7% level. In total, 2013’s cash handbacks amounted to £4.7bn, and there’s a further £1-2bn in buybacks planned for 2014.

A bit wary

This all looks great, especially to someone who likes strong blue-chip dividends, but I confess I’m a little concerned over the low and falling dividend cover. It’s great during good years when the cash is there, but with the cyclical nature of drug development I’d really like to see a little more breathing space between earnings and dividends — at rival AstraZenenca, despite several years of falling earnings, dividends are still set to be covered 1.5 times by 2015.

But on the other hand, ace investor Neil Woodford is a big fan GlaxoSmithKline, and he has a few shares tucked away in his market-beating portfolios.

If you like rising dividends like Glaxo's, you'd probably welcome ideas for some more great shares that should serve you well in the coming decades. And what better way to find them than "The Fool’s Five Shares To Retire On" report?

Check it out -- you just might like the companies it examines. And it's completely free, so click here to get your copy today!

Alan does not own any shares in GlaxoSmithKline or AstraZeneca. The Motley Fool has recommended shares in Glaxo.