Glaxo Undervalued as it Exits Potential Pfizer Deal
The firm’s exit from the process to buy Pfizer’s consumer healthcare business should relive dividend cut concerns.
GlaxoSmithKline’s (GSK) announcement that it has exited the process relating to the potential acquisition of Pfizer’s (PFE) consumer healthcare division should relieve stock pressure stemming from concerns about a potential dividend cut. We don’t expect the decision to affect our fair value estimate or wide moat rating for Glaxo, and we continue to view the stock as undervalued. While dividend cuts are rare in the large-cap pharmaceutical space, they have happened, with Pfizer’s 2009 acquisition of Wyeth leading to the last major Big Pharma dividend cut. We believe the Pfizer precedent probably intensified concern that an acquisition by Glaxo could also lead to a dividend cut. We estimate the value of Pfizer’s consumer division at close to $17 billion, large enough to raise questions as to whether Glaxo could make the acquisition without cutting its dividend.
While we believe Glaxo will continue to support its dividend, management hasn’t provided guidance beyond 2018 regarding the amount. Concerns about the acquisition of Pfizer’s consumer division leading to a dividend cut surfaced on Glaxo’s third-quarter earning conference call last year. Given the high dividend payout ratio--just above 75%, based on our estimate of core 2018 earnings--worries about a dividend cut are understandable. However, we expect Glaxo to post 4% average annual earnings growth over the five-year period following 2018. Further, although 2018 earnings face potential pressures from generic Advair, we expect strong growth in HIV drugs and steady vaccine growth to mitigate this. Given the expected steady earnings growth, we expect the payout ratio will fall to a more manageable level over the next five years.
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Damien Conover does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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