In an ideal world, a company would expand its dividend as it grows its profits and its market share. The payout offered to investors in this instance serves as both a reward for their ongoing support and a promise of future growth. In reality, the factors that determine a stock’s dividend yield are rarely this well aligned.
Sometimes a management team will choose to prioritise the dividend in spite of an uncertain outlook – as pharmaceutical major GSK (GSK) has done. There are a handful of forthcoming catalysts that could have a profound impact on the group’s share price and, by extension, its payouts to shareholders. The first among these is an ongoing legal saga in the US, where tens of thousands of people have filed lawsuits alleging that the heartburn treatment Zantac gave them cancer.
Originally formulated by a GSK predecessor company in the late 1970s, Zantac was considered to be one of the world’s first “blockbuster” drugs. Generic versions were subsequently launched by other pharmaceutical groups, including Pfizer (US:PFE).
In June, the stock received a boost when the company revealed it had reached an undisclosed settlement with a California resident who claimed to have developed bladder cancer after using Zantac. But the lack of share price response to a relatively good set of half-year figures that same month suggests the uncertainty continues to weigh on the shares.
Investors will hope the June settlement sets a precedent for other cases to be settled out of court, as costly and drawn-out trials could restrict the company’s ability to invest in its drug pipeline. Ultimately, GSK’s longer-term growth trajectory, and its payout profile, will be determined by its ability to develop new products and bring them to market.
Some key drugs in its lucrative portfolio of HIV treatments are due to go off patent before the end of the decade – meaning GSK is under pressure to build new revenue streams. It demerged its lower-margin consumer health business Haleon (HLN) last year in a bid to focus more of its resources on the highly competitive prescription pharma market. Whether this pivot will be deemed a success depends on the company’s ability to stock its pipeline and bolster growth prospects in the coming years. The spin-off gave GSK a £7bn dividend that it is using to this end, having agreed a $2bn (£1.6bn) deal for Canadian biotech business Bellus Health in April.
So with acquisitions and research and development spend both increasing, there are competing demands for capital at the business. GSK’s income credentials come via what is described by management as an “aggressive” dividend policy. At its interim results in June, the company’s CFO Julie Brown reasserted that management is committed to maintaining a 40-60 per cent payout ratio as earnings increase over time.
Of course, there is no guarantee of profit growth, but GSK’s comparatively generous dividend is perhaps a show of gratitude to investors who have been patient as the company transforms itself. Those investors would probably mutter that growth in the dividend has been nonexistent in recent years – analyst consensus is that this will change as of 2024. In the meantime, a dividend yield of around 4 per cent – and, given the company trades on a price/earnings ratio of 10, an earnings yield of 10 per cent – will have to make do.
