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GlaxoSmithKline Dividend Concerns Overblown

Damien Conover, CFA

Damien Conover: In the large cap pharmaceutical space there is one name that really stands out from a valuation perspective, and that's GlaxoSmithKline. A lot of the reason why we think the stock is undervalued is there is concern over the company's ability to pay the dividend. If you look at the dividend yield right now, it's over 5% which is much higher than its peer group. Its peer group is closer to 3%. There is quite a bit of difference there, and I think there is growing concern, whether or not Glaxo will have to cut its dividend. 

When we look at the stock, we think there are some negative headwinds coming toward the company, but we think there is enough secure cash flow to maintain this dividend. Just by maintaining the dividend that should enable the company to grow in its current valuation.

The headwinds that I talked about that I think are important to focus on are, number one, its respiratory disease franchise. This is something that Glaxo really leads the industry in. One of its key molecules is called Advair. Advair is used for asthma, COPD. It's a huge, blockbuster product, and its over 10% of the sales for Glaxo. It's very likely as we look into 2018 that generic drugs will launch and take a lot of market share. Now, there is a couple of important things here. First off, Glaxo has a lot of other respiratory drugs that are even better than Advair. There should be some migration to these next generation respiratory drugs. The other piece is when this drug goes generic, when Advair goes generic, the amount of competition from the generic players won't be as intense because it's a very difficult drug that get through regulatory hurdles. You're only going to see a handful of potential generic. Glaxo should be able to retain some of that sales from Advair. We think that headwind is manageable. 

I'd say the other major headwind for Glaxo is within its HIV franchise. Glaxo has been doing very well in HIV, recently launched an integrase inhibitor called Tivicay that should continue to do very, very well. However, Gilead is likely going to launch its integrase inhibitor, its next generation integrase inhibitor in the next several quarters. What we'll likely see is this very strong growth rate from the HIV franchise for Glaxo start to calm down a little bit. We don't anticipate a major drop because once folks are well controlled on HIV drugs, they don't tend to switch around. That growth driver will likely still be a cash flow driver, but not really growing its potential.

These two major headwinds combined with a very high dividend payout ratio right now has got the market concerned. However, we think both of these headwinds are manageable combined with a strong platform in other areas including vaccines, consumer drugs--which are very stable over a long period of time. Vaccines and consumer drugs are close to 50% of total sales, so you have a very stable base. Then those other headwinds we think are manageable. 

We think this all adds up to a stable dividend. Again, we think that stable dividend is strong enough to support increased valuation for GlaxoSmithKline.