Thinking of buying the GlaxoSmithKline share price? Read this first
Shares in global healthcare company GlaxoSmithKline(LSE: GSK) have dived by nearly 13% over the past two weeks. Value hunters might be tempted to jump in after this decline, but before you buy in, there is something I think you should be aware of.
Earlier this year, Glaxo paid around £9bn to buy out the stake of Swiss rival Novartis in its consumer healthcare business, which gave Glaxo full ownership of the joint venture but added significantly to the group’s borrowings. Between the third quarter of 2017 and the third quarter of 2018, Glaxo’s net debt jumped 68%.
To help reduce its borrowings, management put some of the group’s non-core businesses up for sale including the Indian Horlicks operation. FTSE 100 consumer goods giant Unilever recently agreed to buy this business for a total of $3.8bn, which the market applauded. However, only a few days after this deal was announced, Glaxo revealed that it is going to spend all of the proceeds from the Unilever deal (and more) buying oncology-focused US pharma business Tesaro Inc for $5.1bn.
I think this deal could land Glaxo in some serious hot water. Not only is the company borrowing more to fund it, but Tesaro isn’t profitable. Management does not expect the acquisition to contribute to earnings until 2022, in the meantime, Glaxo will have to fund its losses.
I originally sold my holding because I was worried about the company’s debt. The deal with Unilever got me thinking about buying back in, but after the Tesaro deal, I’m not interested anymore.
Credit rating agency Moody’s has already downgraded its outlook on Glaxo’s debt to Negative from Stable citing “weak” credit metrics for a “prolonged period of time” following the buyout.
Glaxo’s rising debt almost certainly puts the group’s dividend in jeopardy in my opinion. For the past four years, it has held its payout at 80p per share. At the time of writing, this is equivalent to a dividend yield of 5.6%. However, the total distribution is consuming around £4bn of free cash flow every year. For the past five years, the company has produced an annualised free cash flow of around £4.5bn, leaving almost nothing to pay down debt.
So far, management has been able to balance Glaxo’s obligations so that it can maintain the dividend at 80p, but to me, it looks as if the group is increasingly running out of breathing room. A slight fall in earnings or higher interest rates could wipe out the company’s slim cash margin and force management’s hand.
And with this being the case, even after falling 13% in around two weeks, I’m not interested in the Glaxo share price. The company just has too much debt, and sooner or later, I think management will have to face the music.
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Rupert Hargreaves owns shares in Unilever. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.