GlaxoSmithKline is set to cut its dividend – should you sell your shares?
GlaxoSmithKline, a top pick for UK income investors, will reduce its dividend after spinning out its consumer healthcare business. So should you sell? Rupert Hargreaves looks over the business's prospects.
In July 2022, the company aims to complete the de-merger and listing of Haleon, its GlaxoSmithKline, a top pick for UK income investors, will reduce its dividend after spinning out its consumer healthcare business. Investors will receive shares in the new entity (the exact number is yet to be confirmed) and will be free to do as they wish with these holdings.
Following the de-merger, Glaxo's remaining pharmaceutical business plans to rebase its annual dividend payout from 80p per share to 43p. Haleon is yet to lay out its dividend policy, but initial comments suggest it will distribute 30% to 50% of earnings.
The separation will mark one of the biggest changes for Glaxo in its long history. The slimmed-down pharma company will receive a one-off dividend of £7bn from the spinoff and a 20% stake, which it can either sell at a later date or hold on to and pocket the dividend income. Haleon’s other joint owner, Pfizer (NYSE: PFE), will receive a payout of more than £3bn and will retain its 32% stake following the spinoff.
The split will leave investors with two very different companies: a nimble global pharma giant, and a consumer healthcare business that’s projecting low single-digit revenue growth for the next few years.
Glaxo’s pharma business could be worth far more as an independent entity
While Glaxo has a world-leading HIV and vaccines businesses, its pharmaceuticals division has often lagged behind others in the sector. The group has been slow to develop its own innovative oncology drugs, for example, and now it is trying to catch up using acquisitions. Its oncology division accounted for just 3% of total pharmaceutical sales last year.
Glaxo’s one-off £7bn payout from the Haleon de-merger will give the remaining businesses a cash infusion, and management will be able to spend the proceeds on research and development as well as acquisitions to drive growth. This should add some much-needed sparkle to Glaxo’s drug portfolio.
There is also a need to find new treatments to fill the gap that will emerge as older products lose their patent protection in the years ahead. The company will lose patent exclusivity on the HIV drug dolutegravir (worth about £3bn a year) at the end of 2027.
The group is making progress filling the gap. In 2020, it received approvals for Blenrep, a treatment for a form of blood cancer called multiple myeloma. Last June, Glaxo agreed to pay up to £1.5bn to iTeos Therapeutics Inc to develop and sell a potential cancer treatment together.
In recent days regulators in the US have also accepted its application for oral chronic kidney disease drug Daprodustat to be approved for sale. The business is estimating peak annual sales for the drug of between £519m and £1bn.
And earlier in April, Glaxo agreed to spend £1.5bn to buy Sierra Oncology, which is testing a drug for anaemic patients with a type of bone marrow cancer called myelofibrosis. Management estimates this treatment could generate peak sales of £1.3bn a year.
Unfortunately, as well as these successes, there have been some failures along the way, but this is just part and parcel of the pharmaceutical business. Only around 14% of drugs succeed in clinical trials and make it to market.
After spinning off Haleon, Glaxo should be able to re-focus on growing its pharmaceutical pipeline, and the infusion of cash from the deal will give the firm much-needed firepower to develop new treatments and fund new deals – it costs £1.3bn on average to develop a new drug.
The two companies could be worth more after the separation
A rough back-of-the-envelope calculation shows the value the de-merger could create for investors.
Glaxo’s vaccines and pharmaceutical arms produced sales of £24.5bn in 2021. Its large US peers are trading at an average price-to-sales (p/s) multiple of 5.4, suggesting the standalone pharma business could be worth as much as £132bn.
On top of this, Glaxo’s FTSE 100 peer Unilever (LSE: ULVR) tabled an offer of £50bn to buy Haleon last year, which was rejected as being too low. However, even at this valuation, these numbers suggest the two entities could be worth as much as £182bn, up from £89bn today.
This is a best-case scenario, and much depends on Glaxo’s ability to generate growth in its drug pipeline. There is also no guarantee the market will award Haleon such a high valuation. It is going to be lumped with a chunk of the parent company’s debt with a projected debt to earnings before interest, tax, depreciation and amortisation (ebitda) ratio of four times at the time of the spin-off, compared to two times for the remaining pharmaceutical business.
Reducing this debt will be a priority for Haleon’s management (headed by former Tesco CEO Dave Lewis) and could weigh on cash distributions for the next few years. What’s more, the new business is only expected to achieve sales growth of 4%-6% a year in the medium term.
Still, with the two organisations trading at a discount of as much as 50% to their peer group and private market values, there’s clearly value here. So look past Glaxo’s upcoming dividend cut, and focus on the ability of these two streamlined companies to unlock value and drive growth through innovation.