Today I am looking at why income hunters could be taking a huge gamble by investing in AstraZeneca (LSE: AZN) (NYSE: AZN.US).
Dividend freeze on the cards
Owing to the effect of enduring pressure on AstraZenecas bottom line earnings are expected to drop 18% in 2014 and 4% in 2015 City analysts expect the full-year payout to remain locked at 280 US cents per share for both of these years.
If realised, AstraZeneca will fail to have raised the dividend for four years on the bounce. Even so, the drug developer still boasts a yield which far outstrips its big cap peers, a figure of 3.9% through to the close of 2015 making mincemeat of the 3.3% FTSE 100 forward average.
On the one hand AstraZenecas expected ability to maintain market-beating yields is to be applauded given the effect of heavy patent expirations in recent years, a testament to the firms ability to keep on generating shedloads of cash.
Still, AstraZeneca does not have a bottomless cash well to call upon in order to fund dividends, and I believe the firm faces a number of problems which could jeopardise dividends in the near term at least.
Patent problems cast a shadow
Firstly, the effect of exclusivity losses across a number of key products means that prospective payments are barely covered by earnings. Indeed, AstraZeneca meagre dividend coverage of just 1.5 times projected earnings well short of the safety standard of 2 times falls even further, to 1.4 times, in 2015.
AstraZenecas revenues performance has improved markedly in recent months, and selective investment across its Brilinta (an antiplatelet product); respiratory; and diabetes core platforms drove collective sales 38% higher across these areas during July-September alone. This helped AstraZeneca enjoy its third consecutive quarter of growth.
However, the business is expected to suffer further significant patent losses which could halt this momentum, including that of pulmonary drug Symbicort next year. The business has already lost exclusivity on stomach treatment Nexium in recent months, and is set to lose protection for its top-selling Crestor anti-cholesterol drug in the US in 2016.
Cash concerns on the rise
The company is ploughing vast sums into R&D and selective acquisitions in order to mitigate such losses and get earnings growth back on the table, but such work is highly capital intensive and shareholder payments are likely to take a back seat as AstraZeneca struggles to get the next generation of revenue-drivers off the ground.
Cash and cash equivalents at AstraZeneca dropped by a third as of the end of September, to 5.15bn, from the corresponding 2013 period, illustrating just how expensive the business of drug development can be.
And of course the road from getting product from laboratory to pharmacy shelf is often beset by delays and, in extreme cases, testing suspensions and cancellations. So there is no guarantee that AstraZeneca rejuvenated pipeline will fill the colossal revenues void caused by its escalating battle against patent losses. Consequently, I reckon that possible dividend pressure could stretch well beyond 2015.
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Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.