Watch out for potential dividend cut at GlaxoSmithKline

As one of the stalwarts of British industry, which has been in the headlines for all the wrong reasons recently, the headline might come as a bit of a shock, but doing a bit of digging makes it seem quite likely that we will see a dividend re-basing or cut from this one, possibly as early as next year.

First off their recent results were awful and led to downgrades which leave this year and next years forecast dividend being around 1.2x covered by earnings and 1x by free cash flow. Analyst also suggest in recent reports that this could fall further to around 1.1x as they divest of some older drugs. Despite this they suggest the dividend will be increased or maintained at worst and the company claim they are sticking with their dividend policy, although they have reduced share buy backs. However, be aware that the divestment of the older drugs may lead to a further special dividend early next year which may be the last hurrah on the income front for this one.

So why worry, well first off there are all the corruption allegations and investigations which are on going in UK, China and now Syria which I guess could lead to some fines and further cash outflows. On top of that I see that there is talk of them spinning off their consumer healthcare arm - which came from an interview with the CEO in the FT which was then weirdly denied. Now if this happens it may be good for shareholder value if the new entity gets more highly rated than the current group P/E of around 14x. The level of income a current Glaxo shareholder will get going forward will then depend on the policy of the demerged arm and the remaining pharmaceutical business. I suggest it will call into question the sustainability of the dividend or give them a great opportunity to "re-base" the dividend as part of that process.

Finally, the clincher for me was the recent story (yet to be confirmed) that Sir Philip Hampton is apparently being lined up for the role of Chairman to replace Sir Christopher Gent. A quick look at his CV shows that he has experience of dividend cuts and omissions having started out as FD of British Steel and most recently as Chairman of RBS.

He also has experience in de-mergers as he was FD when the former British Gas split itself up and created Centrica back in the 1990's. He then became FD of the remaining BG Group in 1997 which then promptly cut its dividend in 1998. Next he moved to BT in October 2000 and helped them with the de-merger of O2 and wait for it the dividend cut the next year.

After that he moved to Lloyds Bank in 2002 as FD for a couple of years which was the exception as they managed to maintain their dividend in that period and he left after a couple of years to join Sainsbury's in 2004 as Chairman. They promptly cut their dividend in 2005. In 2008 he became Chairman of the Government's bank bail out vehicle UK Financial Investments Limited and then onto be Chairman of RBS in 2009.

So the likely new Chairman is an establishment figure who is experienced in de-mergers and is not afraid of tough projects or decisions like cutting dividends. Thus if his appointment as Chairman designate is confirmed I suspect the writing will be on the wall for GSK's distribution. However, I'm not suggesting you rush out and sell them as they look reasonable value on around 14x with a near 6% yield and given the recent fall in the price they also look oversold. Indeed it might even be worth buying them on sum of the parts, break up grounds or even silly season rumours of a Pfizer bid - just be aware that the income from it may not be as sustainable as you might think.