Can GlaxoSmithKline plc & Royal Dutch Shell Plc’s Sky-High Yields Survive 2016?

The FTSE 100 is packed with mind-boggling yields right now, although it boggles the mind how long many can last. Be warned, the higher they go, the riskier they become.

Glaxo Didn’t Go

This time last year I tipped pharmaceutical giant GlaxoSmithKline (LSE: GSK) as one of my favourites for 2015, but how wrong I was. It is down nearly 10% over the last 12 months. Clearly, I failed to understand just how deep-rooted its problems are. It remains too dependent on its respiratory treatment, Advair, a former money-spinner that is now facing pricing pressures in the US and Europe, while its pipeline of 40 new drugs and vaccines in Phase II/III clinical development isn’t ready to pick up the slack as yet. Earnings per share (EPS) fell 13% in Q3, although this largely reflects dilution from the Novartis transaction.

Promises, Promises

All is not lost. Glaxo’s gGroup Q3 sales rose 11%, with its pharmaceuticals, vaccines and consumer healthcare divisions all holding their own. This should help underpin management’s commitment to paying an annual ordinary dividend of 80p for the three years running to 2017. Today’s 6.1% yield of 6.1% is covered just 1.2 times, so Glaxo will need the cash to keep flowing to meet its commitment.

EPS should recover next year, with a forecast rise of 11% to 84.33p. Revenues may stagnate but pre-tax profits are forecast to rise from around £5.1bn this year to £5.74 next year, which suggests that management should be able to maintain its payout, especially given the embarrassment of failing to meet its recent firm promise.

Not So Sure Of Shell

I may have bigged up Glaxo last year but at least I had the sense to dump my holdings in Royal Dutch Shell (LSE: RDSB), which is down a whopping 28% over the past 12 months. Naturally, the plummeting oil price is mostly to blame, and with Saudi Arabia dashing hopes that it would cut production at the recent Opec meeting, it could fall further still.

This is really turning up the heat on Shell, which currently yields 7.1%. Cover for the payout is forecast to fall to just one times, putting it under real pressure. Shell has never cut dividends since the war, but we live in turbulent times, and that proud record could fall next year.

Troubled Waters

Nerves will be frazzled, especially with Shell slumping to a third quarter loss of $6.1bn, well short of forecasts, due to write-offs and lower oil and gas prices. Both net investments and dividend payments were covered from cash flow, however, and is management is keen to point out, the merger with BG Group should boost cash flows.

The yield is supported for now and cost cutting should help Shell buy time. Most of its recent losses were down to writing off projects that weren’t actually producing any oil. It can withstand oil prices for a while, but unless the price picks up in the second half of next year, it may run into trouble: $11.6bn a year is a lot of money.

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Harvey Jones has no position in any shares mentioned. 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.