Five Pharmaceutical Stocks with Big Dividend Yields

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Pharmaceutical stocks can be a very interesting sector in which to look for high quality companies offering big and healthy – pun intended – dividend yields. The sector is prone to big profit margins and strong cash flow generation, and dividend yields are looking really attractive in many cases. Here I'll talk about five big and strong dividends from the pharmaceutical industry

Pharmaceuticals are non discretionary products; people buy most drugs because they need them, not because they want to.  Patients don't cut back on their medicine spending unless they absolutely have to, so sales at pharmaceutical companies are quite resilient in relationship to changes in economic growth or consumer mood. Few industries have the same level of stability when it comes to cash flows generation during tough economic times.

At the same time, demographic trends offer some interesting tailwinds for the industry. With baby boomers reaching retirement age in the US and life expectancy getting longer all over the world, demand seems to be supported by strong secular growth drivers. More and better medicines have made our lives longer, and this also means growing demand for these products, because an elder population tends to consume more drugs and other health related products.

Technological advancement is another positive factor for the industry in the middle and long term. Humankind has discovered vaccines and drugs to cure illnesses which were seriously dangerous – even tremendously lethal – not so long ago. New drugs are discovered all the time, and different uses are given to existing ones. The more we know about medicine, the faster we can progress in drug development, and the future seems very interesting from that perspective.

Developing a new drug can be an expensive and time consuming task, but when a successful product reaches the markets it usually generates enormous profitability for the companies behind it. Production costs are notoriously low in comparison to the sales price of most drugs, so pharmaceuticals usually receive big cash flows from their most effective launches.  The pharma business produces unusually high gross profit margins.

However, the process is not simple at all; developing a new drug can take 15 or 20 years to go through the entire research, development and regulatory process, consuming hundreds of millions of dollars in investments with absolutely no guarantee of success.

For this reason, size is an important advantage in the pharmaceutical business, as big companies have the financial and operating resources to go through this long and expensive process, which can be very challenging for smaller competitors.  

Big companies don't only have the money to bring new drugs to the market, because they can also buy promising developments from smaller companies or even purchase their smaller competitors.

Once a company has established a brand name, a wide geographical presence and a strong sales and marketing relationship with doctors, it is in a better position to continue growing, be it by developing new products or simply purchasing them from smaller competitors. Big pharmaceuticals have the resources to develop or purchase the best drugs, and they also have the marketing power to transform those products into growing sales.

There have been problems affecting the industry lately. Many patents are reaching their expiration date, and the regulatory framework for the healthcare industry is getting more uncertain because governments around the world are trying to reduce costs as much as possible. This has produced some cheap valuations in the sector, and investors can buy some big and strong pharmaceuticals paying attractive dividend yields.

Pfizer (NYSE: PFE) has experienced some rough times over the last few years, as the patent expiration for Lipitor in 2011 hit sales and earnings hard. Also, during the next three years the company will lose patent protection on other important products like Geodon for schizophrenia, Celebrex for arthritis, and Detrol for overactive bladder. But the company has invested heavily in building a big pipeline to replace those lost patents, and it's also evolved in a deep restructuring process.

Pfizer sold its Capsugel unit for $2.3 billion last year. In 2013, it plans to spin off part of its animal-health unit, a deal with an estimated value of $3.8 billion. Another big cash infusion is coming from the $12 billion sale of its nutritional business to Nestle. This means there will be plenty of resources for the company to finance growth and also increase dividends; the current dividend yield of 3.4% is already quite interesting, and it has plenty of upside room in the middle term.

Johnson & Johnson (NYSE: JNJ) is another big pharmaceutical facing some complications lately: Product recalls, regulatory uncertainties and legal complications have produced some considerable negativity around the company. But this is a globally diversified giant with many different business lines and one of the best pipelines in the industry, led by new drugs for oncology, arthritis, and cardiovascular disease. The company pays a 3.5% yield and has an amazing track record of 50 consecutive years of dividend increases. Financial strength is unquestionable in this case, so I expect the dividend will continue rising for a long time.

One company which seems to be doing a nice job when it comes to planting the seeds of future growth is Novartis (NYSE: NVS). This global pharmaceutical operates in four different lines of business: branded pharmaceuticals, generics, vision care and consumer products. In May of this year Novartis announced the acquisition of Foguera, a dermatology company which is expected to add substantially to revenues and earnings at Novartis.

Although acquisitions are certainly one interesting avenue for expansion, Novartis has many other resources to keep growing in the future. The company's generic business, Sandoz, provides the opportunity to grab a portion of the billions of dollars in competitive branded products losing patent protection over the next 10 years. Novartis pays a juicy 4% in dividends, and growth opportunities at the business level should fuel dividend increases in the middle term.

There are many undervalued opportunities in European pharma: GlaxoSmithKline (NYSE: GSK), for example,  yields 4.5% in dividends and has some very interesting prospects  in vaccines and consumer products in addition to its drugs portfolio.  The company has a strong pipeline and is one of the most exposed to emerging markets, where brand names are more important and product cycles are typically longer.

AstraZeneca (NYSE: AZN) faces one of the worst patent cliffs in the industry and holds a relatively weak late-stage pipeline, which explains why the stock is so cheap at a 6.2% dividend yield. The company has embarked in an aggressive acquisition policy to overcome the lack of internal growth, which is certainly a risky path, but it also means big upside potential if management makes the right strategic decisions. AstraZeneca has plenty of financial resources to sustain its dividend, and the company appointed a new CEO this year to reinvigorate the management team.

In case you are looking for big dividends yields from highly profitable companies with low cyclical exposure, and facing growing demand in the long term, these big pharma dividends may be just what the doctor ordered.

acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca plc (ADR), GlaxoSmithKline, and Johnson & Johnson. Motley Fool newsletter services recommend GlaxoSmithKline and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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