As a general rule, I love companies that pay big dividends -- and British pharmaceutical giant GlaxoSmithKline (GSK 0.06%) pays some of the best dividends on the planet. That said, there's one very good reason why GlaxoSmithKline should not be paying a dividend, and that reason is debt.
Currently, GlaxoSmithKline pays its shareholders an annual dividend of $1.04 per share (there are two British "common shares" in each of the American Depositary Receipts bought on the NYSE). Thus, Glaxo's $1.04-per-share dividend works out to a 5.2% dividend yield on every one of the $39-and-change stock's U.S. ADRs.
GlaxoSmithKline's dividend is so large partly because its stock price is so small. Glaxo's profits, you see, are currently depressed by large, and ongoing, restructuring charges, and with profits in the tank, investors have dumped GlaxoSmithKline stock, which is down 9% over the past year in a market that has seen the S&P 500 rise 12%.
As the S&P enjoys a bull market -- GlaxoSmithKline shareholders are enduring a bear. Image source: Getty Images.
A second consequence of Glaxo's weak profits is that the company's payout ratio (the percentage of Glaxo's profits that are paid out to shareholders in the form of dividends) now exceeds 200%. Put another way, for every $1 Glaxo earns in profits, the company pays its shareholders $2 in dividends -- $1 that it has, and $1 that it has to borrow. This is not a sustainable dividend policy.
A history of largesse
And that's not all. According to data from S&P Global Market Intelligence, GlaxoSmithKline stock has paid out nearly $53.4 billion in dividends over the past decade. That sounds like a good thing. But here's another reason why it isn't, necessarily.
For investors who bought Glaxo stock for the dividend, the company has paid off in spades. For investors who own Glaxo stock because they want to be long-term partners in a successful business, the company's generous dividends pose more of a problem.
To see why, take a look at the balance sheet. GlaxoSmithKline currently boasts $5.3 billion in cash in the bank -- but it also carries $24.4 billion in debt. Had Glaxo held onto its cash, rather than paying it out as dividends, the $53.4 billion that Glaxo has paid out over the past decade would have been enough to pay off its debt two times over, leaving the company in much better financial condition.
Dividend rich, debt-poor
Granted, not everyone sees things this way. Citing improved results for GlaxoSmithKline's respiratory and infectious-disease businesses, and the company's 2015 Novartis asset-swap, my Foolish colleague Sean Williams thinks things are looking up for GlaxoSmithKline stock. Wall Street analysts, too, expect the company to grow its profits at a near-7% rate over the next five years. On the other hand, sub-7% is a slower growth rate than Wall Street projects for any of Bristol-Myers Squibb, Novartis, Merck, or Eli Lilly.
One reason Glaxo is expected to under-grow its competition, I suspect, is the company's burdensome debt load. S&P Global Marketplace Intelligence puts Glaxo's debt-to-equity ratio at 4.3, which is far more debt than Glaxo's rivals bear:
- Bristol-Myers, for example, carries only $1.7 billion in net, and on a larger market capitalization.
- Eli Lilly, only slightly smaller than Glaxo, carries only one-third Glaxo's net debt -- $7.1 billion.
- Merck, at $172.6 billion in market cap, is nearly twice Glaxo's size, while its net debt of $13 billion is half what Glaxo carries.
- And Novartis, at $218.4 billion in market cap, is more than twice Glaxo's size, while its $22.1 billion net debt is less than Glaxo's.
Relative to its competition, GlaxoSmithKline has so much debt it leaves itself financially hobbled. Glaxo's interest payments gobble up a lot of the company's profits ($940 million over the last 12 months), and are one factor depressing the company's profit margin below those of any of the other Big Pharmas named. Even so, Glaxo is paying by far the richest dividend of the group -- nearly two full percentage points more than the next most generous dividend payer (Novartis, with its 3.2% dividend yield).
Despite all this, Glaxo's total liabilities have grown for two straight years, and seem likely to grow again in 2017. This, in a nutshell, is why I think GlaxoSmithKline is wasting money paying a dividend. Instead, Glaxo should pay down its debt.
