2.4% Yield And 10+ Potential Blockbuster Drugs

by: The Wall Street Transcript

Would you buy a large-cap pharmaceutical & biotechnology company yielding over 2.4% in current dividend income with more than a dozen promising new drugs in the late stages of the FDA approval process?

Large-cap pharmaceutical corporations have been trading at a discount this year relative to broader market indices. Well publicized reports of impending "patent cliffs" -- when drugs lose their legal patent protection from competitors -- have scared investors with the possibility that many "big pharma" companies will not be able to replace sales of their current blockbuster products with new drugs from their own research & development labs. This drop in their future expected revenue has played out in stock prices that have lagged the overall S&P 500 Index so far in 2012.

The drop in large-cap pharma stock prices has a silver lining: some of these dividend payers are now yielding over 4% in current income. The three highest payers in the large-cap pharma index ETF [PPH] are now GlaxoSmithKline [GSK], Bristol-Myers Squibb [BMY] and Eli Lilly & Company [LLY]. Combined, these 3 stocks have an enterprise value of over $240 billion.

Adding a number of newly identified biotech winners to these large-cap pharma stocks creates a portfolio of equities that has both stable financials and significant growth potential. The combination of the 3 big pharma stocks and the 6 biotech winners identified below is in effect a "do-it-yourself" large-cap biotechnology and pharmaceutical production and distribution blue-chip stock with a significant dividend yield.

The specific biotech stocks that are appropriate for this investment strategy need to have blockbuster products in the later stages of the approval pipeline and they need to be reasonably priced. Obviously, this requires intensive financial research and the scientific ability to assess highly technical claims for specific disease mechanisms.

In a recent interview, Jim Birchenough, a board certified physician and a Managing Director and Senior Biotechnology Analyst at BMO Capital Markets [BMO] explained the methodology for identifying top biotech stocks:

Historically, we've looked at a group of roughly 170 development-stage biotech companies over a four-year cycle, and categorized the companies by stage of development, therapeutic focus, whether they were internally developed compounds or externally in-licensed, and valuation to see if there were some trends in terms of where value is created.

Dr. Birchenough goes on to identify his top stock picks that have resulted from this research:

One good example is Celgene [CELG], where Celgene right now is trading at roughly 13 times forward earnings, and they have the ability to grow earnings long term at a rate of 20% to 25%. That's a very specific example of an area of value dislocation, and we think over the next 12 months, you'll see a multiple expansion with Celgene…

On the midcap side, our top pick right now is Onyx Pharmaceuticals [ONXX], and Onyx is one of the few companies that could emerge from 2012 with three separate drugs for cancer on the market…

Dr. Birchenough offers a small cap top pick to round out his recommendations:

Synta [SNTA] is a development-stage company moving into Phase III with what's called an Hsp90 inhibitor, and Hsp90 is a chaperone, essentially a bodyguard, for key oncogenic proteins in cancer cells, and by targeting Hsp90, you could get different drivers of cancer growth in different tumor types. And this is a highly leverageable platform…

Boris Peaker is an Executive Director and Senior Analyst covering the biotechnology sector at Oppenheimer & Company [OPY]. In an interview on Septmber 17, 2012, he identifies his top biotechnology stock pick for oncology treatments:

...in the oncology space, some of the interesting new developments are Celldex [CLDX] as a new drug in breast cancer, which is targeting a completely novel target, which is certainly exciting with some of the early stages of development, but the initial data is very encouraging...

Matthew Roden is an Executive Director and Senior Analyst at UBS Investment Bank [UBS]. Dr. Roden was named to the 2011 Institutional Investor All-America Research Team as the Rising Star in biotechnology. He also holds a Ph.D. in microbiology and immunology from the Albert Einstein College of Medicine. His biotech picks are companies that develop clinically proven treatments for important disease categories, not necessarily those with smooth talking executives:

To use an analogy, I would say we're betting on the horse, not the jockey. And the reason is that a great management team can't get a really a bad drug approved by the FDA. But a C-minus management team very well may be able to be get a good drug approved despite their limitations, because there are so many stakeholders involved in drug development, including the scientific community, the FDA, many outside advisers and counselors and regulators, they could help steer a subpar management team back on track to get it approved.

Dr. Roden identifies one of his favorites in a September 2012 interview:

In the midcaps, one of our favorite names is Incyte [INCY]. At times, this has performed really well this year, but presently, it made a bit of a pullback on their expectation management around the second-quarter result.

Rounding out the list of biotech stocks with near-term FDA approval inflection points is Cyclacel [CYCC]. A recent 3-day run from September 19 through September has resulted in 25% price increase to around $5 per share for this stock, demonstrating the upside available from positive late stage drug trial results.

Cyclacel is a spin out from the research department of the University of Dundee in Scotland, but is a publicly traded stock in the United States. The CEO of Cyclacel Spiro Rombotis recently identified their drug Sapacitabine as the near-term driver of the stock price: "Sapacitibine is currently in a Phase III trial called "SEAMLESS" in elderly patients with AML (acute myeloid leukemia) under a SPA, or special protocol assessment, agreement we reached with the U.S. FDA."

Combining the near-term high upside potential of these 6 biotech stocks with 3 large-cap pharmaceutical companies creates a portfolio that is the best of both worlds: a large-cap current income producing pharmaceutical company with significant near-term upside due to a robust pipeline of treatments. This "synthetic" 2.4% yield biotech winner can be created with an outlay of about $25,000 by following the chart below:

Company Ticker Price Div. Shares Amount
GlaxoSmithKline GSK $47.43 $2.11 100 $4,743
Bristol-Myers Squibb BMY $34.15 $1.36 150 $5,123
Eli Lilly & Co. LLY $47.71 $1.96 100 $4,771
Celgene CELG $77.78 N/A 25 $1,945
Onyx Pharmaceuticals ONXX $83.27 N/A 25 $2,082
Synta Pharmaceuticals SNTA $8.18 N/A 200 $1,636
Incyte INCY $18.28 N/A 100 $1,828
Celldex Therapeutics CLDX $6.33 N/A 250 $1,583
Cyclacel CYCC $5.00 N/A 300 $1,500
Total $25,215

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.