Big drug companies can add an element of stability to investor portfolios. People get sick and need treatment whether the economy is booming or tanking. And big pharma tends to pay hefty dividends, a valuable source of steady income in an era of low returns on fixed-income investments. Investors in these stocks want to know that the dividend is safe and that there is some reasonable amount of growth that can support a rising dividend and some capital gains as well.
Pfizer (PFE 1.87%) and GlaxoSmithKline plc (GSK 0.11%) are two of the biggest and steadiest in the industry, and both pay generous dividends. Which one is the smarter pick for new money today? Here's how the two compare.
The case for GlaxoSmithKline
Glaxo has made big strides in diversifying its business and strengthening its financials since a 2015 asset swap with Novartis. It has lessened its risk associated with the uncertainties of drug pipeline events, built up free cash flow, maintained a healthy dividend, and put the company on a path for steady growth.
Image source: GlaxoSmithKline plc.
Glaxo's pharmaceuticals segment, which generates more than half of total revenue, is growing by only 2%. The company's HIV drugs are growing at a 13% rate, but the overall pharma business is held back by drugs that are in decline, such as respiratory drug Advair.
Sales for Glaxo's vaccines, which make up 18% of the company's total revenue, are growing at around 5% year over year. The company should get a boost as it starts selling Shingrix, its new shingles vaccine that recently won FDA approval.
The consumer business kicks in around one-quarter of Glaxo's total sales and is growing at a 2% rate. That's more sluggish growth than last year, a trend that the company thinks will continue.
For the near future, earnings growth for Glaxo will probably be no more than the 3% to 5% in constant currency. An improvement in the pharma growth rate is probably coming down the road as the company's pipeline assets are commercialized, but any significant impact could be three to five years down the road.
Glaxo pays a rich 5.75% dividend, but there's a reason it's unusually high. The company announced in July that it was committing to paying the current dividend through 2018, but after that, the payout will be determined quarter by quarter based on free cash flow.
Since the latest free cash flow numbers fall far short of the company's goal for covering the dividend with money to spare for investing in growth, investors are worried about a cut in the dividend in 2019. However, the company's restructuring and cost-cutting efforts are succeeding at growing free cash flow. By 2019, the company should be able to pay the current dividend out of cash without growing debt.
Since Glaxo's investor day, when the upcoming dividend policy was announced, the market has driven the stock price down 14%, primarily on the dividend concern. With at least some of the impact of a payout cut priced into the stock, there is upside potential if the company is able to maintain it through 2019, but more downside if it doesn't.
The case for Pfizer
Pfizer has a significant challenge ahead in growing sales, but it's succeeding in growing profits and has a relatively safe dividend that's yielding 3.6% today.
Image source: Pfizer.
The headwind Pfizer faces is loss of exclusivity for the aging portfolio of drugs in its essential health division, which had a revenue decline of 11% in the most recent quarter. The company expects that the loss of exclusivity will cost the company $2 billion in revenue in each of the next three years, $1 billion in 2021, and $500 million or less per year from 2022 to 2025. That's a gale-force headwind, for sure.
But even with these losses, Pfizer is managing to hold its own on the top line. Excluding a divestiture, the company expects to eke out a revenue gain of a couple of percent on the current year, thanks to growth in its innovative health portfolio, which had a sales increase of 11% last quarter over the year before. And looking forward, Pfizer is on the brink of a multi-year wave of new product launches and product extensions.
The outlook for profit growth is even brighter as a result of declining costs. Adjusted cost of sales year as a percentage of revenue during the first three quarters of the year dropped from 21.9% in 2016 to 19.9% in 2017. Sales and administrative costs have also been cut, contributing to a 10% increase in earnings per share last quarter. Pfizer's midpoint guidance for full-year earnings per share is $2.60, representing year-over-year growth of around 8%.
Pfizer's dividend appears quite safe and is likely to grow. Year-to-date operating cash flow of $9.7 billion has been more than enough to cover the $5.75 billion paid out in dividends, investment needs for growth, and even -- with some expansion of long-term debt -- the repurchase of 150 million shares of stock, about 2.4% of the shares outstanding. I expect Pfizer to continue to raise its dividend, as it did with a 6.7% bump last year.
The winner
I think Pfizer is the better bet for long-term, conservative investors who are looking for a steady source of dividend income that should outgrow inflation, and the potential for capital gains as well. It may be tempting to jump on GlaxoSmithKline's 5.75% yield, especially knowing that a dividend cut that may not happen is already priced into the stock. Indeed, continued cash flow growth and a commitment to maintain the dividend past 2018 may cause Glaxo's stock to outshine Pfizer's in the next year or so. But in my opinion, Pfizer's financial strength and higher profit growth wins the contest for long-term investors like me.
Ironically, a potential deal between the two companies may tilt the picture even more toward Pfizer as well. Last month, Pfizer announced that it's looking at selling or spinning off its $3.4 billion consumer healthcare business that includes brands such as Advil and Centrum. GlaxoSmithKline would be a logical buyer. In the latest conference call, Glaxo CEO Emma Walmsley, herself a veteran of the company's consumer business, acknowledged that the company was interested in bulking up its consumer unit and will be considering a deal with Pfizer. Analysts on the call immediately showed concern for the dividend should a deal be struck.
In the end, Pfizer is in a much better position, with the ability to grow its dividend, continue to buy back shares, and make investments for growth. GlaxoSmithKline will have to make some tough trade-offs with less flexibility, leaving quite a bit of uncertainty for investors.
