Pharma, Cash, and You

All the turmoil in the markets has put pressure on pharmaceutical companies, just like every other industry. While the future could bring slower growth, one thing can't be taken away: the companies' cash. All that cash is telling me that pharmaceutical companies ("pharma" for short) have a lot of fight left in them.

These companies are not going to be just sitting around, either. Pharma has been hoarding cash for a rainy day, and it looks to me like there's a thunderstorm outside that's not likely to go away anytime soon. Not a thunderstorm of danger, but of opportunity.

Here, let me show you:

Company

Cash and Short-Term Investments (billions), mrq

Free Cash Flow (billions), ttm

Pfizer (NYSE: PFE  )

$26.2

$14.8

Novartis (NYSE: NVS  )

$16.2

$14.0

Wyeth (NYSE: WYE  )

$13.6

$3.9

Johnson & Johnson (NYSE: JNJ  )

$13.1

$11.5

GlaxoSmithKline (NYSE: GSK  )

$10.7

$9.9

Merck (NYSE: MRK  )

$10.0

$8.1

Eli Lilly (NYSE: LLY  )

$5.2

$5.4

Source: Capital IQ, a division of Standard & Poor's. mrq = most recent quarter, ttm = trailing 12 months.

Cash now
You may have thought that drug company acquisitions were at a crazy unsustainable pace. With these levels of cash on hand, though, I doubt the companies are likely to slow down anytime soon. Supporting this, some drug developers have been beaten down a lot over the last year, which makes them much cheaper to acquire.

Company

YTD return

Amylin Pharmaceuticals

(48%)

Exelixis

(29%)

Onyx Pharmaceuticals

(35%)

Source: Morningstar

Acquisitions won't be the only thing that pharma will use its cash for. It may be a better move to secure the rights to individual drugs through marketing partnerships -- especially with drug developers that have multiple partnerships already, making an outright purchase more difficult. Such partnerships would cost the companies some cash for upfront payments. Further, deals like this are usually structured so that the pharmaceutical company pays for some or all of the clinical trial work remaining to get the drug approved.

Pharma can and should be willing to spend some of its cash for acquiring drugs, either through company purchase or marketing and development agreements. Just like investing in the stock market when prices are cheap, pharmaceutical companies should be laying out the cash now to reap long-term returns down the road. As long as the return is better than the interest rate it could have earned, making acquisitions or investing in partnerships will be profitable.

Cash later
Not only are the companies fat with cash today, but it's still coming in. That nearly $15 billion of free cash flow that Pfizer brought in over the last year is an astronomical amount of money. To put it another way, that works out to about $2.20 per share in free cash flow.

A little more than half of it, about $8.2 billion or 56%, went toward the dividend. In comparison, Lilly sent some 36% of its free cash flow to shareholders. The rest? Well, just add it to the stash.

Sure, the cash won't be flowing at these levels forever -- most pharmas are facing a patent cliff. Unless a miracle occurs, when Lipitor starts facing generic competition, Pfizer's free cash is going to go down. But that's what the acquisitions and deals are for. And until then, investors should enjoy the added cash, in both the companies' coffers and their own pocketbooks.

Cash is king
It's easy to get caught up in the earnings numbers game. That's what the headlines report and analysts estimate. But earnings can be manipulated and aren't necessarily the best gauge of a company's health.

Cash, on the other hand, can't be manipulated as easily. It's either there or not. And when it is, it provides a lot of options for companies ... and investors in those companies.

Cash is king. Always has been; always will be.

Pfizer, Lilly, J&J, and Glaxo are all Motley Fool Income Investor picks. To see how dividend-paying stocks can offer both secure income and the opportunity for growth, take a free look at this newsletter with a 30-day free trial.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is also a recommendation of the Inside Value newsletter. Exelixis is a choice from Rule Breakers and the Fool owns some shares. The Fool has a disclosure policy.


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