As the market continues to climb to new record highs, many investors are searching for safe dividend stocks paying high dividends (see 28 such companies here).


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The healthcare sector, pharmaceuticals in particular, is generally considered a defensive sector thanks to the recession-resistant nature of its product sales.


However, while this is true as a whole, not all high-yield pharma stocks are created equal.


Let’s take a look at to see if GlaxoSmithKline (GSK), which currently boasts one of the highest yields in the industry, could be a reasonable investment for our Conservative Retirees dividend portfolio.


Business Description

With roots tracing back to 1715 in London, GlaxoSmithKline is one of the world’s largest pharmaceutical companies, with nearly 100,000 employees operating in more than 150 countries.


GlaxoSmithKline has three primary business segments:


Pharmaceuticals (58% of revenue; 68% operating profit): patented drugs treating bacterial, viral (including HIV), as well as respiratory, cardiovascular, urogenital,metabolic, dermatological, and immuno-inflammatory conditions.


Vaccines (16% of revenue; 18% of operating profit): produces and distributes 25 vaccines around the world (833 million doses in 2016) to prevent diseases such as Meningitis, Hepatitis A, Hepatitis B, Tetanus, HPV, Diphtheria, Influenza, Pertussis, Measles, Mumps, Rubella, Typhoid, Varicella (Chicken Pox), Rotavirus, and Pneumococcal Pneumonia.


Consumer Healthcare (26% of sales; 14% of operating profit: oral health, nutrition, and skin health products (in the form of tablets, creams, syrups, and skin patches) under the Otrivin, Panadol, parodontax, Poligrip, Sensodyne, Theraflu, and Voltaren brand names


As you can see, while GlaxoSmithKline is a highly diversified company, the vast majority of its sales and profits come from its patented pharmaceutical division.


That’s because patented drugs, while potentially more volatile and prone to losing market share to competitors and generic rivals over time, have inherently higher margins.


Business Analysis

Like most large pharma companies, Glaxo’s sales and earnings can be highly cyclical and volatile.


In fact, over the past five years the company’s revenue growth has clocked in at -3.6% annually, and its core earnings shrunk every year from 2007 through 2015.


GSK Dividend

Source: Simply Safe Dividends


GlaxoSmithKline GSK DividendThis is precisely because so much of the company’s sales and free cash flow are derived from just a handful of patented drugs.


In fact, GlaxoSmithKline’s top five pharma products accounted for 27% of the company’s total revenue in 2016 (and presumably an even higher share of total profits).


Patented drugs constantly face competitive pressure from rival products and patent expirations that allow much cheaper generics to steal market share.


As a result, Glaxo must continuously invest heavily into R&D and its new drug pipeline to make up for the steadily deteriorating long-term sales of its major patented cash cows, such as asthma drug Advair.


Advair, the company’s top-selling respiratory medicine, accounted for approximately 20% of Glaxo’s total sales and an even greater share of profits at its peak in 2013.


However, the drug lost patent protection in the U.S. in 2010 and in Europe in 2013. Generic competition and price pressure from insurers caused Advair’s sales to decline by 34% since 2013.


Management believes 2017 could be a tough year for sales of Advair in the U.S. because Mylan (MYL) and Hikma Pharmaceuticals (HKMPF) are expected to launch competing generic products.


If those cheaper products win approval from U.S. regulators, management expects core earnings to be flat or down slightly. Otherwise, core earnings are expected to increase 5% to 7% in 2017.


Glaxo’s pharma struggles were a catalyst behind its $20 billion asset swap with Novartis in 2015 that sent Glaxo’s cancer drugs over in exchange for Novartis’ vaccines business and a majority stake in a joint venture that combined the two companies’ consumer health businesses.


Glaxo’s CEO who orchestrated the deal (and has since retired) wanted to diversify the company into these lower-margin, but higher-volume businesses to combat the patent expirations and insurance pricing challenges it faced within its pharmaceutical portfolio.


The global vaccines and consumer healthcare markets are large in size ($18 billion and $70 billion, respectively) and expected to grow at predictable low to mid-single-digit annual rates over the coming years, which should provide more dependable cash flow for Glaxo.


While these moves should in theory provide a more stable operating platform for the company over the long term, pharmaceuticals still accounted for nearly 70% of Glaxo’s total operating profit last year.


In other words, the company still faces risk managing the decline of its Advair drug (12.5% of sales last year) while continuing to develop its drug pipeline, which has failed to live up to expectations for years.


Up until now, the company has managed to keep its return on invested capital at highly impressive rates.


GlaxoSmithKline GSK Dividend


However, in 2016 Glaxo saw its margins and returns on capital fall, especially compared to other blue chip pharma names such as Johnson & Johnson (JNJ). This was mainly due to two factors.


Company Operating Margin FCF Margin Return On Invested Capital
GlaxoSmithKline 9.3% 11.1% 6.8%
Johnson & Johnson 29.4% 21.6% 17.9%
Industry Average 19.5% NA NA

Source: Morningstar


First was a substantial increase in tax liabilities due to having to pay more in taxes than it had anticipated. This resulted in an effective tax rate for 2016 of 45.2%, compared to just 20.5% in 2015.


Management expects its updated tax liability policies to avoid this kind of mistake in the future and projects a 21% to 22% tax rate in 2017.


However, the largest factor to its 2016 earnings drop was a substantial increase in charges and write-offs related to previous acquisitions, joint ventures, and restructuring costs, which totaled almost 4 billion pounds.


GlaxoSmithKline GSK Dividend

Source: GlaxoSmithKline Earnings Release


In fairness to management, these charges are part of its restructuring plan that was announced in 2014, launched in 2015, and has thus far had six quarters in which to run.


In addition, last year’s charges included acquisition-related expenses from acquiring several key HIV drugs from Bristol -Myers Squibb (BMY).


In other words, while the massive charges in 2015 and 2016 may look bad, investors need to realize that once the turnaround plan is completed these charges should become greatly reduced.


The good news is that if you exclude the one-time tax hit, Glaxo’s constant currency sales and adjusted EPS were actually up 6% and 12%, respectively, thanks to strong growth across all its business segments driven by the launch of 11 new product lines.


GlaxoSmithKline GSK Dividend

Source: GlaxoSmithKline Investor Fact Sheet


In fact, Glaxo has done a remarkable job in accelerating the release of new drugs. You can see that new product sales have increased from 8% of total revenue in 2015 to 16% last year. Within the company’s pharma segment, sales from new products total close to

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