A Closer Look at GlaxoSmithKline's Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of GlaxoSmithKline  (LSE: GSK  ) (NYSE: GSK  ) and assessing whether the company is an appetising pick for income investors.

How does GlaxoSmithKline's dividend history stack up?

  2009 2010 2011 2012
FY Dividend Per Share 61 pence 65 pence 70 pence 74 pence
DPS Growth 7.00% 6.60% 7.70% 5.70%
Dividend Cover 2x 0.8x 1.6x 1.5x

Source: GlaxoSmithKline company accounts.

GlaxoSmithKline has steadily grown the annual dividend during the past four years even in times of severe earnings pressure. The effect of more than 4 billion pounds in legal charges caused earnings per share to collapse by more than half in 2010, effectively destroying dividend cover that year, while EPS dipped modestly last year as groupwide sales edged lower.

The pharma giant has also granted extra dividends in recent years. 2011's total payout came to 75 pence following the disposal of various over-the-counter products in North America, adding 5 pence to the full-year payout. GlaxoSmithKline's commitment to keep dividends rolling despite falling earnings has kept coverage below the widely regarded safety reading of 2 times prospective earnings.

What are GlaxoSmithKline's dividends expected to do?

  2013 2014
FY Dividend Per Share 78.2 pence 81.9 pence
DPS Growth 5.70% 4.70%
Dividend Cover 1.5x 1.5x
Dividend Yield 4.70% 5.00%

Source: Digital Look.

City forecasters expect dividends to continue to progress in mid-digit territory over the medium term, helped by a modest EPS bounceback. Earnings increases of 2% and 8%, to 116 pence and 125 pence, are expected this year and next. Still, coverage is still expected to remain stable below the 2 times earnings security benchmark.

GlaxoSmithKline announced in last month's interims that total turnover slipped 2% in the first three months of 2013, to 6.5 billion pounds, in turn driving operating profit down by just over a quarter to 1.6 billion pounds. However, I believe that the company is on the cusp of powering sales higher once more.

Its bubbly R&D pipeline has generated six key drugs currently under review in North America and Europe, which if approved will significantly boost revenues in coming years. The firm is also actively building its presence across the globe, and has also created a Global Established Products division comprising 50 drug brands with annual sales of $3 billion or more to maximize returns here.

On top of steady dividend growth, GlaxoSmithKline's ability to throw up plenty of cash -- net inflows rose to 1.4 billion pounds in quarter one from 1.1 billion pounds in the corresponding period last year -- is also funding the company's hefty share repurchase program. The firm has targeted between 1 billion pounds and 2 billion pounds of buybacks during the current year.

How does GlaxoSmithKline's dividend prospects rate against the competition?

  Prospective Dividend Yield Prospective P/E Ratio
Pharmaceuticals & Biotechnology 2.50% 48
FTSE 100 3.20% 15.5

Source: Digital Look.

GlaxoSmithKline, which currently trades on a forward P/E reading of 14.2, beats its FTSE 100 counterparts on both value and dividend yield. It is also far more appealing than its pharma rivals, particularly in terms of price rating, although the forwards earnings multiple on show here are skewed by a scattering of firms.

A more accurate comparison would be with AstraZeneca, which changes hands on a forward multiple of 9.9 and is expected to yield 5.4% in 2013. However, the expiration of a number of its patents are anticipated to crimp earnings over the next two years, which could have huge ramifications on dividend growth moving forwards.

To conclude, I believe that GlaxoSmithKline is a solid pick for income investors. The firm's ability to grow dividends at a decent rate, even in times of eroding earnings, makes it a comforting bet for shareholder looking forward to steady payout increases. And I reckon that an improving earnings outlook should drive yields further ahead of those of its peers in the FTSE 100 and pharmaceutical sectors.

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