Out of 12 Big Pharma Stocks, This is the 1 You Can Confidently Hold for the Next 10 Years

Source: Centers for Disease Control and Prevention, Facebook.

Few sectors are as hard to get a handle on as healthcare.

Unlike traditional valuation metrics that allow Wall Street and investors to decipher whether a company could be trading cheaply or is overvalued by quickly looking at profits, margins, cash-versus-debt, or any number of ratios, healthcare industry investors have to take into account intangibles that often include how large a patient pool a pipeline of experimental products could treat, and how rare or chronic the diseases are.

The allure and danger of Big Pharma
Sitting atop the healthcare industry are a dozen major pharmaceutical companies, affably known as "Big Pharma." While you could certainly argue that there are more than 12, I've excluded any pharmaceutical giant with a valuation below $45 billion, and I've removed traditionally large biotech names such as Gilead Sciences, Celgene, Biogen, and Amgen. Biotech companies typically are smaller, have thinner pipelines, but have generally higher growth prospects than Big Pharma which has slower growth but well-established pipelines. 

What's left is the following group of companies, boasting some of the deepest product portfolios and pipelines imaginable:

Yet in spite of their often substantial cash flow, many Big Pharma stocks are struggling to grow. Competition from up-and-coming biotechnology stocks coupled with patent exclusivity losses have made life difficult for this group. Patent losses have been so pervasive for some Big Pharma stocks that it could be many more years before they even stem their revenue decline. Big Pharma stocks are particularly attractive to long-term investors because of their healthy cash flow, superior margins, profits, and branded drug pricing power, and ultimately their highly coveted dividends. With the exception of Shire and Novo Nordisk, the remaining 10 Big Pharma stocks all pay a minimum 2% dividend yield, with many well above this mark.

Source: Novartis.

Some use shareholder incentives to mask a lack of growth
Some companies have turned to share buybacks and/or dividend increases in order to reward their shareholders while reprioritizing their drug development pipelines. I'm not in any way knocking this strategy, since taking care of shareholders is precisely what Big Pharma management should be doing. However, there's a fine line between inflating the bottom-line with share buybacks and masking a lack of organic growth.

Pfizer, for example, has been shellacked by the loss of exclusivity on cholesterol-fighting drug Lipitor, the all-time best-selling drug, as well as Detrol, Celebrex, and, in select markets, Spiriva. Over the last four years, Pfizer's annual revenue has declined from $67.8 billion to the $49.6 billion it recorded in 2014. This year, Pfizer offered guidance of between $44.5 billion and $46.5 billion in total revenue, implying yet another year of sales declines.

Despite these declines, Pfizer has returned in the neighborhood of $65 billion to shareholders over the past four years between share repurchases and dividends. Having fewer shares outstanding clearly boosted Pfizer's EPS, but spending $65 billion to merely mask a lack of organic growth isn't a sustainable strategy for the company over the long-term.

Some Big Pharma stocks lack direction
Other Big Pharma stocks are simply struggling to figure out what to do next. In this group I'd lump names such Eli Lilly, AstraZeneca, and GlaxoSmithKline.

Source: GlaxoSmithKline.

GlaxoSmithKline is a particularly interesting case, as it offers a 5%-plus dividend, more than twice the average yield of the S&P 500, while still offering substantial cash flow. However, its cash cow is Advair/Seretide, a long-term therapy used to treat COPD and asthma that's lost patent exclusivity and which will be exposed to generic competition by as early as next year. Generic drug pricing will cause Advair's price to plummet, and will likely erode 50% or more of Advair's total revenue in short order. According to Wall Street's EPS forecast into 2017, Glaxo may not be able to cover its current dividend.

This isn't to say GlaxoSmithKline has nothing brewing in its pipeline. It does have a handful of COPD products -- Breo Ellipta, Anoro Ellipta, Incruse Ellipta, and Arnuity Ellipta -- for long-term COPD or asthma maintenance, and it recently jettisoned its oncology division to Novartis in exchange for Novartis' vaccine division, making Glaxo something of a vaccine powerhouse. But the pathway to stable growth is far from certain for GlaxoSmithKline.

Source: Merck & Co.

Some are too reliant on a single drug for their turnaround
For other Big Pharma stocks -- namely Merck and Bristol-Myers Squibb -- there appear to be signs of top-line stabilization creeping in, but they're both far too reliant on single therapies to lift up their growth prospects.

To be 100% clear, it certainly looks as if anti-PD1 inhibitors Keytruda from Merck and Opdivo from Bristol-Myers Squibb are going to be every bit the blockbusters Wall Street expected they could be. Keytruda is currently being tested in 30 different indications, and both Keytruda and Opdivo have a good shot at being studied in multiple trials as combination therapies. If these immune system-enhancing drugs have even half the effectiveness these drugs showed as a last line of defense for metastatic melanoma, sales of both could top $5 billion, in my opinion.

Ultimately, though, this is just one drug for each company. While Merck and Bristol-Myers are working with other drug hopefuls, one drug is unlikely to stem the tide of exclusivity losses for either company, making a long-term hold on both a bit of a risk.

But this Big Pharma looks just right!
Within the Big Pharma sector sits one company that's having no trouble packing on the profits, and which also looks poised to deliver significant shareholder gains over the next 10 years. If you're considering an investment in the healthcare sector for both growth and income purposes, I'd suggest you consider Johnson & Johnson.

Source: Johnson & Johnson.

To be upfront, Johnson & Johnson isn't entirely a pharmaceutical company. It's a healthcare conglomerate, and is one of the largest medical device companies in the world. It also possesses a pretty solid lineup of health-based consumer products. The investment thesis behind these two segments is that medical device demand should increase as life expectancies grow, especially within the U.S. as baby boomers age, while the consumer products segment tends to boast strong pricing power, and will often grow around or slightly above the rate of inflation.

But the bulk of growth for Johnson & Johnson comes from its pharmaceutical segment. Since 2009, J&J has successfully launched 14 new drugs which, as of mid-year 2014, had cumulatively totaled more in sales than any of its major pharmaceutical peers. With Gilead's hepatitis C drugs raking in the dough last year I'm not certain J&J would be No. 1 anymore in drug sales since 2009, but J&J nonetheless achieved its No. 1 ranking behind a diverse array of drugs, which is probably better from a long-term standpoint when it comes to patent expirations.

For J&J investors there isn't just one reason to be excited about its pipeline -- there are multiple reasons.

Source: Johnson & Johnson.

Blood cancer drug Imbruvica, which is licensed from Pharmacyclics, has the potential to earn well over $5 billion in peak annual sales per Wall Street estimates as it's tested in various blood-borne and solid tumor cancers and combo therapies.

Invokana is a revolutionary SGLT2 inhibitor designed to block glucose absorption in the kidneys and allow type 2 diabetics to excrete excess glucose in their urine. This new pathway has also delivered a helpful side effect of weight loss in patients, which is good news since diabetes and being overweight or obese have a tendency to go hand-in-hand.

Xarelto is another rapidly growing drug in J&J's product portfolio. At the end of its latest quarter it maintained approximately 60% market share in the U.S. oral anticoagulant market, and roughly 15% market share worldwide. As its potential label indications expand, Xarelto's impact on J&J's top- and bottom-line could grow.

Best of all, J&J is riding a 52-year streak of increasing its dividend payout. Based on Wall Street's estimated 2015 EPS forecast, J&J's payout ratio is a mere 45%, which implies plenty of coverage for further dividend increases.

While you may be able to find a higher yield elsewhere within the Big Pharma sector, I'd opine that Johnson & Johnson is the one stock in this sector you can confidently buy and hold for the next 10 years.