Is GlaxoSmithKline plc’s Dividend About To Be Cut?

Over the last four years, GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) has increased dividends per share at an annualised rate of 5.4%. That’s well above inflation for the period and means that shares in the pharmaceutical giant now yield a highly appealing 5.5%.

However, with a dividend increase of just 0.8% forecast for next year, GlaxoSmithKline is expected to hold dividends steady in the following year. Could this be the prelude to a period of reduced dividends?

A Challenging Sector

The pharmaceutical sector is going through a very challenging period, since a number of key, blockbuster drugs are going off-patent and the majors are struggling to replace them. Certainly, they are making steady progress, with acquisitions being the choice of some of GlaxoSmithKline’s peers, such as AstraZeneca, while others are perhaps more reliant on long term, stable growth within their own businesses, such as Johnson & Johnson‘s consumer and medical device divisions.

Of course, GlaxoSmithKline is not immune to the challenges facing the sector. Its top line is now just 82% of what it was four years ago and, in its most recent quarterly results, it reported further challenges regarding generic competition, pricing and volumes. For example, group pharmaceutical and vaccines sales fell by 3% in its most recent quarter, with the US and Europe posting declines of 10% and 2% respectively. Clearly, GlaxoSmithKline is struggling to generate growth.

Payout Ratio

Also of concern for investors in GlaxoSmithKline is the fact that it has a rather generous payout ratio. For example, it pays out 87% of profit as a dividend which, while affordable, does not leave the company with a substantial amount of profit to reinvest in the business to develop future growth opportunities.

As such, it seems to be in a position where the payout ratio cannot realistically move much higher, so improved profitability is likely to be needed before it can increase dividends at a decent pace.

Looking Ahead

In the company’s favour, of course, is an excellent pipeline of new drugs. While it will take time for them to make an impact on sales numbers (and there is no guarantee that they will), GlaxoSmithKline seems to be in a relatively strong position regarding its long term future. And, with its ViiV Healthcare division moving from strength to strength, it could help to significantly boost the company’s long term growth profile.

So, while in the next couple of years GlaxoSmithKline’s dividends may disappoint somewhat, for long term income investors it remains a very sound choice.

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Peter Stephens owns shares of GlaxoSmithKline and AstraZeneca. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.