The Best of Big Pharma for 2013

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Many large-cap pharmaceutical stocks experienced a great year in 2012. Eli Lilly (NYSE: LLY) saw its share price increase more than 20 percent. While impressive, Eli Lilly hasn’t been able to provide investors with a dividend increase in almost three years. Pfizer’s (NYSE: PFE) stock had an impressive year as well, climbing 18 percent, but now sells for a trailing price-to-earnings ratio of almost 21. One stock in the industry that did not enjoy a run up over the last year is GlaxoSmithKline (NYSE: GSK), a company that offers both value and dividend growth. Because of that, Glaxo looks to be the most attractively priced pharmaceutical stock.

Segment Overview

Glaxo is a UK-based, $107 billion pharmaceutical company with a broad array of products. The company operates through three segments: Pharmaceuticals, Vaccines, and Consumer Healthcare. Glaxo had a successful fiscal year 2011. Underlying sales for the company increased 4 percent year over year. Sales growth was spread across its business units: Pharmaceuticals increased by 2 percent, Vaccines increased by 11 percent, and Consumer Healthcare grew by 5 percent.  Glaxo’s business is spread across the world, deriving 68 percent of its sales from outside the United States.

The company’s global reach is a reason to be optimistic about future growth. Emerging markets made up more than 19 percent of the company’s sales in 2011.  Revenues grew nearly 6 percent year over year, which made the emerging markets segment the fastest growing segment for Glaxo in 2011. The company plans to continue building its emerging market segment to capitalize on growth in the developing economies. This will be accomplished through a combination of organic investment as well as targeted bolt-on acquisitions.

Replenishing the Pipeline

As with all pharmaceutical companies, a replenished product pipeline is critical to protect against expiring patents.  Consequently, Glaxo has committed to not just spending heavily on research and development, but targeting spending specifically to the most promising products. One particularly exciting development is that Glaxo is on the cusp of the world’s first malaria vaccine. At the end of 2011, Glaxo reported that its vaccine reduced the risk of malaria by half in late-stage trials. More broadly, Glaxo has 15 medicines and vaccines in Phase III development. The rate of return on investment for research and development increased from 11 to 12 percent in 2011, and the company has established a long-term goal of 14 percent return on R&D spend going forward.

Pfizer, meanwhile, had a rough start to 2012.  During the first nine months of the year, Pfizer's net revenues declined almost 11 percent year over year.  No doubt, Pfizer is struggling after losing the patent on its blockbuster cholesterol drug Lipitor in late 2011.  However, Pfizer is spending heavily on research and development to replace lost sales.  Pfizer had 22 programs in Phase III development at the end of 2011, and has spent more than $26 billion on R&D from 2009-2011. 

Likewise, Eli Lilly's sales dropped almost 9 percent during the first nine months of 2012 versus the prior year.  Eli Lilly had seven products earn at least $1 billion in sales at the end of 2011, and is counting on future growth with the 12 medicines it has in Phase III development.  Lilly also has another 23 programs in Phase II development.  While Lilly is optimistic about its future growth, investors should take note that the company does not give specific guidance about when it will resume growing its dividend--only that it guarantees the dividend won't be cut.

Like its peers, Glaxo faced financial challenges in 2012.  However, Glaxo has navigated the tough economic climate better than Pfizer and Eli Lilly.  Glaxo’s net sales were down 5 percent in the third quarter and only 4 percent through the first nine months versus 2011.  Glaxo points specifically to its lagging European sales, which declined 9 percent year over year, as the primary reason for its difficulties. That being said, the company believes it will return to sales growth in the fourth quarter, as the global economy continues its gradual recovery.

Shareholder Returns

The success of Glaxo’s business has resulted in big dividends and share buybacks. In 2011, the company increased its dividend and initiated a share repurchasing plan. In total, capital returned to shareholders increased by 75 percent versus 2010.  Glaxo increased its dividend again in 2012, and believes it has the financial flexibility to continue doing so for the foreseeable future.  At a share price of $44, Glaxo’s stock yields over 5 percent. Eli Lilly and Pfizer have seen such run-ups in their share prices that they now yield less than 4 percent, meaning Glaxo has a significantly higher dividend yield than its peers. Not only is Glaxo's dividend more competitive, but it hasn't seen the huge rally that its healthcare peers have seen.  Glaxo trades at a trailing price to earnings ratio of slightly less than 14, a forward multiple of only 11.5, and an industry-leading dividend yield; therefore, the company represents the best buy within the pharmaceutical space.

Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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