The healthcare sector has been known for paying dependable dividends and producing strong total returns over time. Among the major pharmaceutical companies, there are a few that stand out as most financially sound, as reflected by their CDS spreads below those of the U.S. Treasuries.
Why use CDS spreads?
A credit default swap is essentially like a form of insurance, that two parties can swap between one another for protection against default. When we talk about CDS spreads, we simply mean the amount of “protection” the buyer most pay the seller for taking on its risk of a debt default. The spread is denominated as the percentage of the face value that makes up a CDS’s premium. The lower the spread, the lower the premium, and less risky a buyer is. Searching for low CDS spreads is one method investors can use to parse the market down into companies with the lowest risk profiles.
The group consists of six pharmaceutical companies with yields of about 3% or higher, which can be considered “safe” from the perspective of credit risk. This feature does not necessarily speak about their capacity to pay high dividends, but it assures that the companies have a rock-solid financial standing that makes them desirable for prudent investors.
Let’s get started
Bristol Myers Squibb Co. (NYSE:BMY) pays an attractive yield that is currently lower than its five-year average yield of 4.5%. The reason for this is a cumulative 78% gain in Bristol Myers Squibb Co. (NYSE:BMY)’s stock price over the past five years. The company’s revenues and profitability have suffered due to patent expiration on its antiplatelet drug Plavix and antihypertensive drugs Avapro/Avalide. However, the period 2010-2013 should be the peak for the company’s revenue erosion due to generics. Its portfolio of new potential blockbusters includes an anticoagulant drug Eliquis (marketed jointly with Pfizer), with a potential to reach $4 billion in peak sales in the next five years, a multiple myeloma treatment Yervoy, which could reach peak sales of $2 billion within five years, and diabetes treatment Onglyza, which could see peak sales of $1 billion.
This potential and the company’s strong financial profile, along with an appealing dividend, are already priced into Bristol Myers Squibb Co. (NYSE:BMY)’s stock, which is trading at above-industry 21x forward earnings. In terms of hedge fund interest, last quarter, Bristol Myers Squibb Co. (NYSE:BMY) was popular with RenTech’s Jim Simons and Adage Capital’s Phill Gross. It’s important to track hedge fund activity; because it’s helped retail investors beat the market by an average of 18 percentage points a year, historically speaking.
Eli Lilly & Co. (NYSE:LLY) also pays a 3.5% yield that is 130 basis points below the company’s average over the past five years. Eli Lilly & Co. (NYSE:LLY) has kept its payout fixed at 49 cents per quarter since February 2009. Given its payout ratio in the lower range of the averages of its main rivals, the company has more room for dividend growth. Currently, Eli Lilly is fighting patent expiration on its antipsychotic drug Zyprexa, which had peak sales of $5 billion and came off patent in 2011. Its antidepressant drug Cymbalta and diabetes treatment Humalog are due to lose exclusivity this year.
Despite these headwinds, Eli Lilly & Co. (NYSE:LLY) is expected to produce EPS growth of between 12% and 16% this year. The company has some potential blockbusters in its pipeline, including dulaglatuide, a new diabetes treatment in the late-stage trial and Ixekizumab, a psoriasis treatment, ramucirumab, a new breast-cancer drug, and Alzheimer’s drug solanezumab. Still, analysts see flat EPS growth for Eli Lilly & Co. (NYSE:LLY) over the next five years on average. Eli Lilly & Co. (NYSE:LLY) is trading at 15.6x forward earnings. Last quarter, Jim Simons held nearly $400 million in this stock.
The best of the rest
Johnson & Johnson (NYSE:JNJ) pays the lowest dividend of the featured six pharmaceutical majors. Its yield is only 20 basis points below the average over the past five years. The company has raised dividends for 50 consecutive years. Johnson & Johnson (NYSE:JNJ) lost patent protections on Concerta, Levaquin and Invega in 2011 and 2012, with Aciphex, a heartburn drug, scheduled to lose its exclusivity this year. Velcade and Remicade, Johnson & Johnson (NYSE:JNJ)’s blockbuster drugs for multiple myeloma and autoimmune diseases, respectively, will lose patent protection in 2014.
Despite the patent cliff, the company is expected to grow its EPS at a CAGR of 6.6%, among the highest in the industry. The company’s revenue losses due to patent expirations will be mitigated by sales of new drugs, such as Zytiga for prostrate cancer, Invokana (canagliflozin) for type-2 diabetes, and Invega for schizophrenia. The company has fortress balance sheet and boast a strong sales potential in emerging markets. Johnson & Johnson (NYSE:JNJ) is priced at 15.6x forward earnings. Last quarter, it was popular with value investors Ken Fisher and Donald Yacktman.
To be continued
The three stocks discussed above are solid income-oriented plays moving forward, and their attractive risk profiles adds to the allure. Be on the lookout for part two, which discusses the remaining three stocks in this group.
Disclosure: none
