The Best Big Pharma Dividend

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It's sad that we should be getting excited about dividends holding steady, but that's where we're at in the pharmaceutical industry.

Drugs go off patent, leading to generic competition, which lowers revenue substantially, which in turn hurts cash flow. That cash is needed to pay the dividends; they don't grow on trees, you know.

The dividends are at such a high level now that just sustaining them makes the stock a decent risk-reward proposition. The dividend by itself won't make for a stellar investment, but it should provide a floor for how low the stock can go, which reduces risk.

Then once investors are convinced that the pharmaceutical companies can grow again, they'll increase their valuation metrics and the share price will increase. Dividend yields might return to lower historical levels, but if the companies are actually growing again, dividends will also increase, which results in more capital appreciation. It's a nice cycle that can only benefit investors.

A patent cliff like no other
Eli Lilly (NYS: LLY) may not have the biggest patent cliff in dollar amount, but being one of the relatively smaller pharmaceutical companies, the loss of four blockbuster drugs -- Zyprexa, Gemzar, Humalog, and Cymbalta -- within a couple of years of each other is going to hurt. So when the company announced earlier this month that it was committed to keeping the dividend at the current level, investors should have been content.

They weren't. Shares declined as short-term-focused investors were more worried about this year's earnings guidance that missed analysts' expectations. I haven't been an Eli Lilly bull because there's very little in the pipeline to excite me, but with a dividend yield now sitting at 4.9%, there are worst places you can park your money. The extra risk, compared with a treasury bond, is more than made up for by the added return.

One big product
Bristol-Myers Squibb (NYS: BMY) will lose exclusivity on its flagship product Plavix this year, and it's going to hurt. A lot. The blood thinner, which it sells with Sanofi (NYS: SNY) , made up 34% of sales during the first nine months of last year.

But the company has a solid pipeline, arguably the best of the large pharmaceutical companies. Eliquis, which it'll sell with Pfizer (NYS: PFE) , should be able to replace much of the sales lost by Plavix. And it keeps snatching up high-growth companies, as it did with its purchase of Inhibitex this week.

It seems management has confidence in the pipeline as well. The board of directors increased the dividend this year. While it was only a token $0.01 raise, sometimes it's the thought that counts.

A raise seven years in the making
Merck
's (NYS: MRK) goal for the year is to keep its revenue constant. In normal circumstances that wouldn't exactly be a resounding vote of confidence, but in August, the company will lose exclusivity on Singulair, a $5 billion drug, so making up for that loss is pretty impressive.

The growing sales for drugs not going off patent gave management confidence to raise its dividend, something it hasn't done since it lost Vioxx in 2004. The massive 10.5% increase over the old dividend level shows a degree of confidence, but investors really need to see a few years of increases before the pharma becomes a dividend dynamo.

Which one?
Of the three, I like Bristol-Myers the best. It has the richest valuation and the lowest dividend yield, but there's a reason for that. Bristol-Myers has the best pipeline of the bunch and therefore the best chance of turning things around post-patent cliff. I'm going to go with Buffett on this: A great company at a fair price trumps a lower quality company with a lower valuation.

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At the time this article was published Brian Orelli owns no shares of the companies mentioned.Motley Fool newsletter serviceshave recommended buying shares of Pfizer. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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