Big Yields in Drug Land

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

Often the best opportunities can be found in unloved sectors that still boast strong business fundamentals. One such industry today is pharmaceuticals. This group has been a laggard for a while and for good reason. That said, there are many companies in the industry that boast strong businesses and likely have the wherewithal to survive and prosper through the current pharmaceutical malaise.

Where to Start?
A good place to start when looking at any industry is a major index. For pharmaceuticals, one need look no further than the Dow 30, which holds both Pfizer (PFE) and Merck (MRK), as well as more diversified Johnson & Johnson (JNJ). I recently took a look at this trio myself. However, it doesn't make sense to stop with the Dow or any other index. A few more companies worth looking at for the dividend investor include: AstraZeneca (NYSE: AZN), Eli Lilly (NYSE: LLY), Bristol-Myers (NYSE: BMY), and for the more aggressive, PDL BioPharma (NASDAQ: PDLI), though the risks here probably outweigh the benefits.

The big problem in the pharmaceutical industry is a fundamental one. For years, companies survived by selling massive amounts of a small number of drugs. Patent protections made this possible. However, those drugs are losing their exclusive status. Drug companies haven't been able to find replacement drugs of the same scale, leaving potentially large holes in their top and bottom lines. It's no wonder that the industry has lagged behind the broader market.

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The transition has been difficult and companies have reacted in a number of ways. Cutting staff, cutting research efforts, and merging are some of the tactics companies have taken to deal with the problem. While this has been a difficult period , for both the companies and their shareholders, many of the pharmaceutical industry's players are still financially strong and well run, and it is likely that they will figure out a way to survive this industry shift. Meanwhile, for dividend investors with a long-term view, there may be some potential bargains to be had.

AstraZeneca was created by the merger of Sweden's Astra and the U.K.'s Zeneca Group. It's pipeline is less robust than many of its peers, but it appears to have at least a few years worth of patent protection on key drugs (new formulations could further extend the patent expiration dates). This should give the company some time to bring new drugs to market.

Patent expirations, however, aren't the only negatives here. The company has been acquisitive, but to mixed results. For example, with the benefit of hindsight, management appears to have overpaid for MedImmune a few years back. The departure of the company's CEO in early 2012 following weak earnings results is another concern, though it might actually be a good sign. Making shareholder friendly changes may be easier with a new CEO in charge. That said, 2012 is likely to be a transition year and 2013 may not be as strong as some would like.

With a yield around 6%, it might be worth the risk of taking a position here. While there are larger and more financially solid companies around, their yields are a good two percentage points lower. While AstraZeneca shouldn't be your only drug exposure, including it in a list of a few other companies would be a reasonable way to increase your portfolio's overall yield. Note that the company is foreign and pays dividends on a non-standard schedule.

Eli Lilly
Eli Lilly's dividend yield of around 4% is about in line with the industry's largest players. It has a strong history of innovation and solid leadership, but it faces one of the least desirable patent expiration profiles. Well aware of this fact, management has gone to great lengths to solidify its industry position. For starters it purchased ImClone, which many believe it overpaid for, and cost cutting has been a key focus. These efforts, plus research and development, could help the company weather this storm. A strong animal health division should also be supportive.

That said, if anything should go wrong over the next couple of years, performance could be worse than many expect. That could open up the possibility of a dividend cut. Dividend focused investors would probably be better off investing in other drug companies than taking on the risks associated with Eli Lilly—particularly since it's priced in line with what appear to be better positioned peers.

Yielding around 4.3%, Bristol-Myers's yield is only slightly higher than other major pharmaceutical industry participants. With a massive amount of its top line coming from drugs quite literally at the end of their patent protection, this may not be enough of a discount. Indeed, despite a decent pipeline of new drugs that appear to be progressing well through the regulatory system, patent expirations are likely to keep earnings weak for several years.

Once this rough patch is over, however, the future will likely be much brighter. The company has been selling assets to focus on its core drug businesses and has achieved decent success partnering with other industry participants. This could position the company for strong results, just not in the near term. Bristol-Myers is probably a good company to keep on the watch list for price weakness that brings the yield close to the 5%-6% range. This would likely be enough of a discount to justify the top and bottom line stagnation that is likely over the near term.

PDL BioPharma
PDL BioPharma has a patented process to create humanized antibodies. The company earns revenue by licensing its technology to produce humanized antibodies to other companies. While this has led to strong revenue growth, patents don't last forever. With a high level of debt on top of being a one-trick-pony, investors are probably better off avoiding this company's impressive 7.9% dividend yield.


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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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