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By: Ahmed Ishtiaq

The biotech sector has some of the most attractive stocks with high dividend yields. The sector has become extremely interesting due to the patents situation and recent M&A activity. A number of big players in the market are facing patent losses and want to replace revenue loss with new drugs. As a result, most of the big fish are currently looking at smaller fish to fill the hole in their revenue streams. Regardless of the patent losses, these big fish have massive cash reserves and incredibly strong cash flows.

We decided to pick three giants from the sector with high dividend yields along with attractive multiples. We will try to explain why these stocks can be good long-term plays and how they can maintain their dividends. We have tried to analyze the free cash flows, payout ratios and earnings growth of these companies one by one.

GlaxoSmithKline plc:

GlaxoSmithKline (NYSE:GSK) is one of the best dividend paying stocks in the sector. It has a solid history of dividend payments and regular hikes in annual dividends. At the moment, the stock pays $2.32 per share, which takes its dividend yield to 5.52%. The company has extremely impressive free cash flows to back its dividend payments. At the end of last year, GSK generated $4.9 billion in free cash flows and paid $3.6 billion in cash dividends. Based on the free cash flows, the payout ratio for the company stood at just above 73%. However, for the trailing twelve months, GSK dividend payments have exceeded the free cash flows.

Furthermore, GSK TTM (Trailing Twelve Months) dividends stood at $3.9 billion whereas free cash flows were $3.1 billion. In the previous twelve months, capital expenditures have gone up for the company along with a decline in operating cash flows. As a result, free cash flows have come down taking the payout ratio above 100%.

However, I believe the decline in the operating cash flows is temporary, and the company will augment its cash flows soon. GSK has made important acquisitions, particularly the acquisition of Human Genome Sciences for $3.6 billion, which could prove to be crucial. The acquisition will yield benefits in the long term with an addition to the product pipeline. Currently, GSK demonstrates an EPS growth of around 5%, which should be augmented by the integration of new acquisitions. At the moment, the stock is trading at a P/E ratio of 13.5, making it a relatively inexpensive investment compared to its peers.

Eli Lilly & Co:

Eli Lilly (NYSE:LLY) is another company in the sector with an attractive dividend yield. The company pays an annual dividend of $1.96, yielding around 4.27%. In addition, the company has an impressive history of dividends. Eli Lilly has maintained its current level of dividends for the past four years. Furthermore, the company generates extremely impressive cash flows. At the end of 2011, it generated $7.2 billion in operating cash flows and $5.5 billion in free cash flows. On the other hand, the company paid $2.1 billion in cash dividends, taking its payout ratio to around 38% based on free cash flows. A low payout ratio has enabled the company to maintain its dividends.

For the last twelve months, Eli Lilly has generated $4.77 billion in free cash flows and paid $2.18 billion in cash dividends. TTM payout ratio is 45.70%, which is still manageable. Operating cash flows have come down for the company during the past twelve months, resulting in lower free cash flows and a high payout ratio. Through its innovation and strong financial position; the company has been successful in developing key drugs. A low payout ratio will help the company maintain its current level of dividends. At the moment, the stock is trading at a P/E ratio of 12.4, significantly below the industry average of 16.8.

AstraZeneca:

AstraZeneca (NYSE:AZN) has dynamic operations and aggressive acquisitions strategy. The company has an impressive portfolio of drugs and a strong pipeline. The company has a policy of paying 50% of earnings in cash dividends. At the moment, AstraZeneca pays an annual dividend of $1.80 per share, and a dividend yield of 4.10%. As a result of the dividend policy, AstraZeneca dividends fluctuate with its earnings. The stock is trading at a deep discount compared to the industry. At the moment, AZN has a P/E ratio of 9.1 compared to the industry average of 16.8. In addition, the company has exceptionally strong free cash flows.

At the end of last year, it generated $6.5 billion in free cash flows and paid $3.76 billion in cash dividends. The payout ratio based on Free Cash Flows was around 58% for the last year. In the last twelve months, AstraZeneca has made significant capital expenditures. Consequently, the free cash flows have gone down considerably. TTM free cash flows and dividends were $2.7 and $3.6 billion, respectively. AstraZeneca will replace its expiring patents with new acquisitions. As I mentioned, the company has an aggressive acquisitions strategy and has been able to replace its drugs. At the moment, the company is rumored to be interested in the takeover of Amarin Corporation (NASDAQ:AMRN) for its lead drug Vascepa.

Summary:

The three Pharmaceutical giants mentioned in this article have a huge presence in their respective markets. Due to their massive size, these companies have been able to weather storms in the past. Solid free cash flows and manageable payout ratios mean these companies can maintain current dividend levels. Almost all of these giants are trading at a discount compared to the industry and offer juicy dividends. These giants will get through the patent expiration pains and add drugs to portfolio to make up for the revenue loss. A strong financial position will enable these three companies to carry on strong earnings growth.

Source: 3 Biotech Giants With High Dividend Yields