Recently, with the loss of patents causing generic competition, the main attraction to pharmaceutical companies has been their dividend. While there has been little to no revenue growth, at least they've offered a hefty dividend to justify holding them. The patent cliff won't last forever. At some point, growth will return, and investors can get paid to wait.
That is, as long as there's enough cash flow to support the dividend. For Eli Lilly (LLY +1.47%) the free cash flow, defined as cash from operations minus capital expense, decreased substantially last year.
|
Metric |
2010 |
2011 |
2012 |
|---|---|---|---|
|
Free Cash Flow (in millions) |
$6,163 |
$6,563 |
$4,399 |
|
YOY Increase (Decrease) |
73% |
6% |
(33%) |
Source: S&P Capital IQ. YOY=Year-Over-Year.
Ouch
It's not quite as bad as it looks, though. Part of the decrease in free cash flow can be attributed to an increase in capital expenses, which jumped from $672 million in 2011 to $905 million last year. But 2011 was a multi-year low. In fact, the last time Eli Lilly had capital expenses that low was in 2000. I wouldn't necessarily expect capital expenses to jump another 30% this year.
The rest of the drop in free cash flow was due to a 27% decrease in cash from operations. To calculate cash from operations, you start with net income and add back in depreciation and amortization expenses, other non-cash items, and changes in working capital.
Net income fell just 6%, matching a 7% decrease in revenue, but that's a bit misleading. In 2012, Eli Lilly received a $788 million payment from Bristol-Myers Squibb (BMY +2.69%) after AstraZeneca (AZN +0.00%) and Bristol bought Eli Lilly's former partner Amylin Pharmaceuticals. When the companies ended their relationship, Amylin got full control of Byetta and Bydureon, and Eli Lilly got a royalty and milestones that Bristol paid off.
The one-time payment has to be subtracted out to calculate cash from operations since we want to know how the company is doing on a day-to-day basis. On that pro forma basis, net income fell about 24%. The rest of the change in cash from operations can be attributed to a change in inventories and accounts payable. Both tend to bounce around a lot, so there's nothing to worry about unless we start to see a multi-year trend.
The decrease in income can be largely attributed to a 63% decrease in sales of Eli Lilly's top drug, the antipsychotic Zyprexa, after the drug lost patent protection.
Cash is king
Despite the massive decrease in free cash flow, Eli Lilly was sitting on a large enough cushion that it didn't have any problems paying its dividend last year.
|
Metric |
2010 |
2011 |
2012 |
|---|---|---|---|
|
Dividends Paid (in millions) |
$2,165 |
$2,180 |
$2,187 |
|
Payout Ratio |
35% |
33% |
50% |
Source: S&P Capital IQ.
At 50% of its free cash flow, Eli Lilly's dividend seems safe and in line with other pharmaceutical companies. Johnson & Johnson (JNJ +1.98%) paid out 53% of its free cash flow as dividends last year, and Merck's (MRK +2.58%) payout ratio was even higher at 63%.
Of course, both of those companies raised their dividends last year, and Merck has already raised its dividend in 2013. Johnson & Johnson, for one, is a much more diversified company than Merck and Eli Lilly, and has a lot less exposure to blockbuster drugs losing patent protection. Meanwhile, Eli Lilly's dividend has been stagnant since 2009. Clearly management saw its steep patent cliff coming and avoided getting over extended.
This year, the dividend looks safe. Eli Lilly will lose patent protection for its insulin Humalog, a $2.4 billion drug, and its current top-selling depression drug Cymbalta in December, but it expects to see revenue growth in 2013.
Next year will be more of a challenge with an entire year of Cymbalta, a $5 billion drug, experiencing generic competition. But there's still enough of a cushion to absorb a decrease in free cash flow and pay its dividend. If worst came to worst, Eli Lilly is also sitting on $5.7 billion in cash that could be used.
For now at least, Eli Lilly's dividend looks safe.
