The wisdom of investing in large, stable companies that pay an attractive dividend has stood the test of time. That said, not all dividends -- or large companies, for that matter -- are created equal.
British pharma giant GlaxoSmithKline (NYSE:GSK), for example, appears to be an exception to this time-tested investing strategy. The company pays a dividend of 4.7% at current levels, making it one of the highest among health care stocks. Moreover, analysts seem to expect fairly steady growth in adjusted earnings per share over the next several years. Viewed this way, Glaxo looks like a stellar long-term buy.
That being said, there are three compelling reasons the company looks to me more like a classic value trap.
Reason No. 1
In April, Teva Pharmaceutical (NYSE:TEVA) launched a generic version of Glaxo's former blockbuster Omega 3 pill Lovaza. Glaxo reported that first-quarter sales of the drug had already dropped 25% in anticipation of the launch of the cheaper generic.
While Glaxo certainly has other drugs in its arsenal, I am unconvinced the company can compensate for this substantial revenue loss and grow earnings in the manner expected by the Street. In fact, projected earnings growth is expected to come mainly from cost savings via an ongoing reorganization.
Keeping with this idea, the market uptake of Glaxo's new asthma therapy Breo Ellipta has been slower than expected due to insurance issues, putting more pressure on the company's other new respiratory medicines like Anoro and Incruse to generate top line growth. And when we dig into this restructuring process a bit further, I think it raises the next major question mark hanging over the company.
Reason No. 2
In something of a surprising move, Glaxo recently traded its high-margin oncology unit for Novartis' (NYSE:NVS) less profitable vaccine business. Although it's true that this move bolsters one of Glaxo's core areas of expertise, oncology is among the fastest-growing segments within the pharmaceutical industry because these drugs often have long commercial lifespans and high profit margins.
The thinking on the Street is that Glaxo decided to exit oncology because of its string of high-profile clinical failures. Backing up this assertion, Glaxo made this announcement less than a month after its lung cancer vaccine MAGE-A3 failed in a second late-stage trial.
What's important to understand is that MAGE-A3 was once believed to be a potential blockbuster that would go on to become one of Glaxo's top oncology treatments. So it's certainly possible that these clinical setbacks drove the decision to drop oncology and focus on vaccines That said, I think the lack of a dedicated oncology unit will end up hurting Glaxo's long-term growth.
Reason No. 3
And then there's the mess in China that seems to be getting worse by the day. Glaxo ran into trouble last year when a 10-month probe turned into allegations that top-level managers were bribing doctors and hospitals. At first, it appeared that the scandal only involved Chinese managers, but authorities have since charged the company's British boss in China, Mark Reilly, with bribery as well.
It's unclear if this scandal will ultimately impact Glaxo's fundamentals or outlook moving ahead. My guess is that fines will be levied against the company, but the bigger impact might be slower growth in emerging markets due to tighter regulations. Given that emerging markets were the one bright spot in the first quarter for pharma sales, this certainly could become a keystone issue down the road.
Despite falling U.S. sales for pharmaceuticals and vaccines in the first quarter of this year, Glaxo's stock shrugged off the larger downturn in the health-care sector, churning higher by 5.3% year to date. Part of this strong performance is undoubtedly due to growing EPS stemming from the company's restructuring. Nonetheless, you have to consider how falling sales for a handful of established products, the company's exit from the cancer market, and self-imposed marketing restrictions in some emerging markets could affect top line growth moving forward. Given these question marks, investors might want to exercise caution with this top health-care name, despite its better than average dividend.
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George Budwell has no position in any stocks mentioned. The Motley Fool recommends TEVA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.