Dow 30 Long-Term Pharma Dividend Plays

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

The pharmaceutical industry has been a laggard for quite some time now. There has been good reason for the underperformance, but the overall strength of many of the companies in the industry has largely been overlooked. Moreover, the products drug companies sell are more often than not necessities. Dow 30 giants like Pfizer (NYSE: PFE) and Merck (NYSE: MRK) are a good starting point for dividend-focused investors interested in this space, though they are not the only options.

The big problem in the pharmaceutical industry is a fundamental one. For years, companies here made their money by having an exclusive right to sell drugs with huge sales figures. A single product could account for a material portion of a company's top and bottom lines. Those blockbuster drugs have been harder and harder to come by, however, making the one-hit-wonder business model less effective. Meanwhile, the patent protection that these firms enjoy is time limited, so the big money makers of yesteryear are going away without replacement. Investors have avoided many of these companies as the industry retrenches and adjusts to a new world order.

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The transition hasn't been a smooth one, to say the least. Companies have been cutting staff, cutting research efforts, and merging, among other initiatives, to change their business models for a world without, or at least with fewer, blockbuster drugs. While this has been difficult, for both the companies and their shareholders, many of the pharmaceutical industry's biggest players are financially strong and well run. It is likely that these companies will figure out a way to survive this. Meanwhile, for dividend investors with a long-term view, there may be some potential bargains to be had.

Pfizer
Pfizer is the world's largest drug company. In fact, its recent purchase of Wyeth has cemented that industry position. Size brings a lot of benefits in the pharmaceutical space because research is everything and research is expensive. Moreover, new drug candidates can be unpredictable, leading to the need to have multiple research efforts going at one time. A company with the size and scope of Pfizer can pull that off.

That said, Pfizer has some major headwinds to deal with, some of its own making. For one, Lipitor, one of its biggest drugs, has lost patent protection. This will cut into the top and bottom lines. Two, integrating Wyeth is likely to be a complicated affair that lasts for quite some time, which opens the possibility for mistakes. Three, upper management has been cutting costs, including on the research and development side of the business. So-called brain drain could be a longer term risk that won't be apparent for several years.

Still, the company is financially sound and has historically performed reasonably well. There is good reason to believe that Pfizer will thrive over the long term. A dividend yield around 4% makes this Dow-30 member a good option for more conservative dividend investors. Note, however, that the dividend was cut a couple of years back. Although the board has begun increasing the dividend again, it's an issue worth watching closely.

Merck
Merck is another giant drug company that has recently acquired another firm. This has taken Merck from a truly tenuous industry position to one that has far more potential. Indeed, the purchase of Schering-Plough solidified what many believed was a very weak drug pipeline. This couldn't have come at a better time, since Merck was facing some material patent losses, including for its hit drug Singulair.

While the pipeline is healthier, that doesn't solve all of Merck's problems. In fact, the company has appeared to have difficulty getting some of its new candidates past regulators. So there is still some execution risk involved with the combined entity. In addition, the merger creates its own execution risks, since bringing two large pharmaceutical companies together is no small affair. Such deals, and the subsequent cost cutting, could result in a similar brain drain to what Pfizer faces.

Merck is a large and well financed company that should survive the current transition period. Moreover, it looks like it is in a better position to handle the transition today than it was prior to the Schering acquisition. A near 4% dividend yield should make dividend investors with a stomach for slightly more aggressive investments interested in this drug giant. Note that the dividend, which had been static for many years, has started to grow again.

Johnson & Johnson (NYSE: JNJ)
Another company worth considering is Johnson & Johnson, which is much more than just a drug company. While this venerable company is definitely a major player in the drug space, facing the same challenges and working toward the same solutions, it also has material operations in the consumer products and medical devices arenas. This provides a level of diversification that the other two Dow drug companies can't provide. A slightly lower yield, at around 3.5%, makes Johnson & Johnson a little less desirable on a relative basis, but it has an impressive history of dividend increases and business success. Conservative income investors would do well to keep this one on their watch lists.

Outside the Dow
There are a host of large non-Dow 30 drug companies worth looking at, too, of course. Among them are AstraZeneca (AZN), Eli Lilly (LLY), and Bristol-Myers (BMY). Then there are smaller, more aggressive dividend paying pharmaceutical firms like PDL BioPharma (PDLI), that might attract the eye, but the risk may not be worth taking. I've taken a look at some of these companies in a sister article.

Yours,


ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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