One 5% yielder I’d consider over GlaxoSmithKline plc

FTSE 100 pharmaceutical giant GlaxoSmithKline (LSE: GSK) faces a number of challenges in 2018.

With the drug maker unlikely to emerge from its earnings plateau for some time, amid growing competitive pressures in its HIV and respiratory businesses, there’s growing concern about the sustainability of its dividends.

Dividend frozen at 80p

GSK has frozen its annual dividend per share at 80p since 2015, but still it has struggled to generate enough profits and free cashflow to afford its current level of shareholder payouts. Net debt has climbed from £10.7bn at the end of 2015 to £14.2bn by the end of September 2017.

And although free cashflow has improved significantly in recent months, thanks to a positive currency benefit and the launch of new products, the company’s financial flexibility could come under pressure as it ponders the acquisition of Pfizer’s consumer health unit.

Little earnings movement

The earnings plateau is expected to continue for some time ahead, as the impact of new product launches is expected to be offset by the legacy effects of patent losses on key products like respiratory drug Advair. Although City analysts expect underlying earnings to have grown by 8% this year, they expect a 3% reversal this year. And for 2019, they think there will be a rebound in its bottom line of just 4%.

Although valuations aren’t pricey, with the shares trading at just 12.2 times expected earnings this year, the risk of a dividend cut continues to overhang its shares. As such, GSK’s current 6.1% dividend doesn’t tempt me right now.

A better pick

Instead, I reckon automotive, cycling and leisure retailer Halfords (LSE: HFD) represents a better dividend pick. In my view, the company has better fundamentals which give it a positive earnings outlook — an important criterion for dividend growth.

Halfords reported a 3.2% increase in sales over the 15 weeks to January 12, after strong trading in its cycling division. Like-for-like sales at its car maintenance division were also positive, with sales up 2.1% over the same period on improved car headlamp bulb and de-icer sales.

However, on the downside, Halfords cautioned that it expects the UK retail environment to “remain subdued” and warned that it would face higher costs because of the weaker pound. But I’m still more sanguine about its earnings prospects, due to the positive top-line picture, with growing like-for-like sales, and new store openings in the UK and in Europe.

Defensive appeal

In addition, unlike most retail stocks, Halfords is an intrinsically defensive stock. This is because car maintenance and repair, a non-cyclical business, makes up around 70% of revenues. After all, customers can’t avoid taking their cars for their annual MOT or conducting necessary repairs, due to legal requirements and the need to the keep their vehicles in good working order.

Halfords’ earnings multiples are similar to GSK’s, with shares in the retailer trading on 12.2 times expected earnings this year. And on top of this, the stock yields 5.1%

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Jack Tang has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. 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.

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