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Is GlaxoSmithKline plc’s Dividend Safe?

GlaxoSmithKline (LSE: GSK) has found the last few years to be very challenging. Its sales have fallen as generic competition has eaten away at the market share of key, blockbuster drugs while it has been embroiled in allegations of bribery, notably in China.

Furthermore, its bottom line has fallen in each of the last three years and, in addition, is now expected to fall for a fourth year in a row. Meanwhile, investor sentiment has weakened and sent the company’s shares downwards by 12% in the last three years.

Hugely enticing

However, where GlaxoSmithKline has enjoyed success is as an income stock. Its dividends per share have risen in each of the last five years and the company now yields a hugely enticing 6.3%. That’s over 50% higher than the FTSE 100’s yield of 4% and means that GlaxoSmithKline is viewed as a top notch defensive stock by many investors.

Despite this, GlaxoSmithKline’s dividends could be a cause of concern for its investors. That’s because, while it is aiming to keep dividends at roughly 80p per share over the next few years (which would amount to a yield of over 6% per annum), there is a danger that they could be slashed. That’s because they account for almost all of GlaxoSmithKline’s profit, with the company due to have a payout ratio of 95% next year even though its bottom line is set to rise by 12%.

Clearly, a payout ratio that high may be sustainable if GlaxoSmithKline were a business which required little in the way of reinvestment. For example, a services-based business may not need to buy property, plant and equipment and, while GlaxoSmithKline may not either, it is required to invest extremely heavily in its drug pipeline and in R&D, to help ensure that its future top and bottom line performance is significantly better than it has been in recent years.

On a positive note, GlaxoSmithKline is aiming to generate at least £1bn in cost cuts over the next few years. This will undoubtedly help to relieve pressure on margins and is a key reason why its guidance is improved versus its recent financial performance. However, it may not present sufficient breathing space for the business with regard to its dividend and, realistically, it would not be a major surprise if dividends were shaved over the medium term.

Extremely appealing

This, though, would not reduce GlaxoSmithKline’s appeal as a long-term income stock. It would most likely still yield considerably more than the FTSE 100 and, with an excellent pipeline stuffed full of treatments at advanced stage clinical trials, its growth profile is extremely appealing. This, when combined with its track record of dividend growth (they have risen by over 4% per annum during the last five years) shows that it remains a shareholder-friendly business which is keen for its investors to share in the company’s success via increasing dividends.

So, although a dividend cut would not exactly be welcome news, GlaxoSmithKline would still be among the best income stocks around for investors seeking to cope with low interest rates over the medium to long term.

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Peter Stephens owns shares of GlaxoSmithKline. 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.