In the hunt for sustainable dividend yields, investors have rushed into the stocks of major pharmaceutical companies. These stocks are widely bought for their blue chip status and hefty dividend yields. Investors likely feel peace of mind buying these stocks, as medicine and health care are fairly recession-proof.
All the while, big pharma stocks continue to grind higher, signifying that the bulls currently have the upper hand. Of course, momentum can reverse in a heartbeat. Therefore, should investors continue to believe in the rally? Or are big pharma stocks ripe for a pullback?
Staring into the void
It’s no secret that the pharmaceutical industry is grappling with a steep patent cliff. Several companies are losing patent protection on critically important drugs. For example, Pfizer Inc. (NYSE:PFE) once had the world’s best-selling drug, Lipitor, all to itself. Now Lipitor is under intense pressure from generic competition, and the resulting effect this has had on Pfizer Inc. (NYSE:PFE) can’t be ignored.
In its recent quarter, Lipitor raked in $545 million in sales. That’s an incredible amount of money, no doubt. However, consider that Lipitor brought in nearly $10 billion in sales as recently as 2011. At the time, Lipitor sales totaled almost as much as the company’s next three best-selling drugs combined. Fast forward to today, and Lipitor is Pfizer Inc. (NYSE:PFE)’s fifth-best selling drug.
Not surprisingly, the loss of patent exclusivity is having an undeniable effect on Pfizer’s results. Pfizer Inc. (NYSE:PFE)’s full-year 2012 sales fell 10%, which management blamed specifically on losing Lipitor.
This has extended into the current year. Sales through the first six months of 2013 are down another 9%.
Meanwhile, Eli Lilly & Co. (NYSE:LLY) has performed better than Pfizer Inc. (NYSE:PFE), because Eli Lilly isn’t facing as steep a patent cliff (yet). Total revenue climbed 6% in the second quarter, and earnings per share soared 34% year over year.
This is due largely to the success of Eli Lilly & Co. (NYSE:LLY)’s blockbuster drug Cymbalta. Sales of the drug increased 22% in the second quarter, and Cymbalta now accounts for 25% of Eli Lilly & Co. (NYSE:LLY)’s revenue.
But again, we see the potential dangers of a pharmaceutical company this reliant on one drug. Just as Pfizer is now feeling the effects of a blockbuster drug losing patent protection, Eli Lilly & Co. (NYSE:LLY) is about to suffer the same thing.
That’s because Cymbalta loses patent protection in the United States in the fourth quarter of this year. Eli Lilly & Co. (NYSE:LLY) is guiding at least $22 billion in 2013 sales and at least 19% EPS growth for the full year. Those would represent strong numbers, no doubt, but it remains to be seen whether or not Eli Lilly & Co. (NYSE:LLY) can sustain this kind of growth in future years, after it loses its best-selling drug.
Bristol-Myers Squibb Co (NYSE:BMY), meanwhile, is up a staggering 35% just to start this year, and that doesn’t even include the hefty dividend payments that big pharma stocks are known for.
After such a strong run-up to begin the year, Bristol-Myers Squibb Co (NYSE:BMY) now trades for a whopping 25 times this year’s earnings, based on full-year expectations for at least $1.70 in 2013 EPS.
These gains have come despite relatively unimpressive results in recent quarters. Bristol-Myers Squibb Co (NYSE:BMY) posted a 9% drop in second-quarter sales, due mainly to the U.S. patent expiration of Avapro and Plavix last year, two of the company’s biggest sellers. These expirations caused U.S. net sales to fall 22% in the quarter, year over year.
Ignore fundamentals at your own peril
Clearly, investors have essentially shrugged off the tenuous industry fundamentals facing the major pharmaceuticals. Investors continue to buy big pharma stocks broadly, due to their competitive dividend yields and blue-chip status.
On those fronts, investors are right. Pfizer, Eli Lilly, and Bristol-Myers Squibb Co (NYSE:BMY) continue to pay dividends near 4% and should pass on regular, albeit modest, dividend increases going forward.
At the same time, it’s rarely advisable to buy stocks for dividends alone. There are intense pressures facing the big pharma stocks that are dragging down sales and profits.
Put simply, the combination of rising stock prices and stagnating fundamentals is a dangerous game for investors to play. While each of these companies are well-run and highly profitable, investors would be wise to wait for the storm clouds hovering over the industry to pass before jumping in.
Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Robert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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