Wednesday, 2 July 2014

BUY: GlaxoSmithKline--Get in quick whilst on naughty step?

Price: 1576.45
Shares: 50
Projected annual dividend income: £40

I finally jumped and made a GlaxoSmithKline purchase. You may remember that previously I have agonised over whether (or rather when) to put money into GSK. Other options certainly crossed my mind. I have also been temped to top up my holding in HSBC whilst its share price is still languishing a little and, more likely, pick up some BAE Systems.

So why did I end up plumping for GSK?

Good Value for a Good Company

With the various issues GSK have been faced with including bribery scandals the price has been somewhat depressed of late (down a little over 5% in a year). This is despite the fact that many were buoyed by the Novartis deal which should yield good results in the future. As a result, when I looked at GSK exactly one month ago it appeared you could get an excellent company at a pretty good price.

However, since then this has changed for the better with the share price dropping a little further and the analyst predictions not shifting a great deal. As a result, the P/E ratio has looked very nice for a company of GSKs long-term quality.

For 2014 they came out like this:

EPSP/E Ratio
Difference (%)15.63
For me, neither the highest predicted P/E of just short of 16 nor the consensus P/E look particularly scary. Obviously it is far from the P/E target of 10 I look at for most shares. But with a company like GSK (and indeed Unilever) you're unlikely to get that sort of bargain anytime soon.

What is more, the predictions are incredibly close together (only 15% difference between the low and high predictions). You can thus assume that analysts feel pretty comfortable with their predictions.

For 2015 the situation looks even more pleasing:

EPSP/E Ratio
Difference (%)23.83
This is what caught my eye. Most (although not all) analysts expect the earnings per share (EPS) to drop this year for from its 112.2p point last year. However, they seem fairly confident it will return to that level (plus some) for 2015.

Consequently we see a not too challenging consensus P/E of about 14. None too shabby. The low prediction, however, is a warning that not everyone is convinced GSK will bounce back so swiftly.

Overall, however, I am quite happy with this.


Of course, GSK is famous for its dividend stalwart status. And this seems set to continue going forward as well. The standard dividend itself still looks very healthy even though analysts have revised the share predictions down a little since early June.

For 2014 and 2015 they expect a dividend payout of 81.2p and 83.76p per share. This represents a 5.15 and 5.31% yield on the price I paid. Very nice indeed.

However, there is a cautious warning in this. With the EPS predicted to drop this year compared to last whilst the dividend is set to grow the dividend cover appears a little slight at under 1.3 times earnings. However, it seems that with a predicted return to growth next year the cover will (modestly) increase. It remains to be see if the cover will increase yet more beyond that. This will be something I will be watching for.

A Couple of Other Cautions

Beyond that, you may pick up on a couple of other concerns. Firstly the book to market value is about 0.1. Seeing as anything under 1 is considered "overvalued" clearly GSK fits into that category on that count. But again, for a company of GSKs quality you would expect that.

More worrying is the debt to equity ratio. This stands at 2.61. In other words, for every £1 of shareholder equity, GSK owes £2.61 in debt. That is very high. The healthy figure is around the 1 mark. 

However, as the Motley Fool noted in February the interest cover is 10 times.* In other words, GSKs earnings (before tax etc) could cover the interest payments by 10 times. This highlights that GSKs huge cash flow minimises the risks this debt represents.

What Next?

Overall, I am very happy with the GSK purchase. It now comprises about 13% of my portfolio and is a welcome counter weight to my large investment in banks (see HSBC, Barclays etc).

I will be keeping a look out, however. Firstly, if the price continues to get dented by various scandals then I may find myself increasing my stake. 

Worries which may cause me to jump ship earlier than expect? A growing debt level would concern me somewhat. Similarly, a dropping dividend cover value would also raise alarm bells. 

The debt level does not hugely worry me as yet as it is an inevitable part of the industry GSK is in. However, the cover would concern me more but I do expect that to improve noticeably in the medium term.


* Sorry for not providing a more up-to-date figure.

[Creative Commons image reproduced from Flickr user Ian Wilson (foolstopzanet)]

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