Dividend stocks are generally a great addition to any portfolio. When mulling over dividend-paying candidates, though, there's a lot more to consider than simply the yield. High-yielding stocks, after all, might be offering a disproportionately large payout because of a fundamental problem with its underlying business, causing its share price to suffer (i.e., the yield increases because the share price dips).
The healthcare companies GlaxoSmithKline (NYSE:GSK) and PDL BioPharma (NASDAQ:PDLI), for instance, offer ginormous dividend yields of 5.2% and 10.5% at current levels, respectively. However, these sector-crushing yields probably aren't safe over the long term. Here's why.
Glaxo's pharma revenues are tumbling
The struggling pharma giant gave investors a sliver of hope at the close of the second quarter by reaffirming its commitment to keeping its dividend of approximately $1.24 per share stable through 2017. But with pharma sales already dropping 7% in the first half of 2015 because of the loss of its oncology business and falling sales for its flagship respiratory drug Advair, and this decline expected to accelerate with the introduction of generic Advair in the U.S., it may be increasingly difficult for Glaxo to keep this promise to shareholders.
Glaxo's plan centers on maintaining the recent sales momentum for its next-gen respiratory products such as Anoro and Breo Ellipta, as well as in its HIV and vaccine franchises -- and then hoping its robust clinical pipeline consisting of more than 40 new experimental products in mid- to late-stage testing can help to return the company to growth by as early as next year.
The problem with that rosy scenario is that Glaxo has been one of the unluckiest Big Pharmas when it comes to developing its late-stage clinical pipeline over the past several years. As a reminder, Glaxo has seen its most promising experimental therapies for Duchenne muscular dystrophy (drisapersen), lung cancer (MAGE-A3), and cardiovascular disease (darapladib) all flame out in pivotal trials, which is a major reason the company is in the unenviable position it is today. If its luck doesn't change before Advair sales fall further, the company may have no choice but to consider lowering its dividend.
PDL's main revenue source is evaporating
PDL is perhaps the highest-yielding dividend stock in the healthcare sector -- excluding stocks paying special one-time dividends -- but that's at least partially because its stock price has been nosediving over the past year:
Unlike most of its peers that make and then, well, sell stuff, PDL focuses on generating revenue through licensing and loan agreements. The company was formed around the so-called "Queen Patents" that covered several top-selling drugs such as Roche's Avastin and Herceptin.
However, these core patents expired at the end of 2014, and the company is only earning money from them now because of a settlement with Roche that essentially extended their shelf life until 2016. But because the Queen patents still made up 84% of the company's $138.1 million in second-quarter revenues, there is serious concern among investors that PDL's earnings and revenues could plummet by 2017.
To counter this problem, PDL's management has been busy lending money to healthcare companies with the goal of earning interest on the loans, or capturing single-digit royalties from the sales of their key products. So far, PDL has struck a total of 14 deals, committing over $1 billion in capital to this endeavor.
Unfortunately, this move to shift its business away from the Queen patent portfolio is far from a sure thing. The problem is that PDL is striking deals with companies such as Ariad Pharmaceuticals that would otherwise have to resort to dilutive secondary offerings to meet their current financial obligations. If Ariad's flagship blood-cancer drug Iclusig underperforms expectations and/or its lead experimental compounds flame out in clinical testing, this deal may ultimately not be worth much for PDL's shareholders.
Without a clear way to replace the Queen patent revenues, PDL's monstrous yield looks like a goner in the not-so-distant future.
High-yielding dividend stocks may look like a dream come true for investors seeking income-generating assets, but there is often a very good reason yields are exceedingly high. Both Glaxo and PDL BioPharma are facing a tough road ahead, causing a marked sell-off in their shares over the last year or so. While the management teams of both companies have tried to reassure investors that they have a viable plan in place to at least maintain their dividends at current levels, there's enough uncertainty surrounding their business prospects moving forward to think otherwise. As such, you may want to look elsewhere for income that's sustainable for the long haul.
George Budwell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.