Gilead Sciences Should Pay a Dividend, But It Won't

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We know that companies that pay dividends often offer better returns than their nondividend-paying counterparts, but this leaves biotechnology stock investors focused on companies such asGilead Sciences at a disadvantage.

Historically, blue-chip companies have been the biggest providers of investor-friendly dividends, and this has meantdividend-paying health care stocks have predominately been big-market-cap pharmaceutical companies, not biotechnology companies. That said, a number of biotech companies, including Gilead Sciences, are maturing to the point at which a dividend should arguably begin being paid. Despite that maturation, however, a dividend pay-out by Gilead Sciences seems unlikely.

Why it should pay a dividendGilead Sciences' product pipeline includes five different HIV therapies that could achieve billion-dollar blockbuster status this year, along with and two hepatitis C drugs -- Sovaldi and Harvoni -- that are among the planet's top-selling compounds.

Sales of Gilead Sciences' HIV drugs climbed 12% to more than $7.4 billion through the first nine months of this year and after winning FDA and European approval for Sovaldi, a hepatitis C drug, Sovaldi has gone on to rack up more than $8.5 billion in sales during the period, too.

Gilead Sciences' market share leadership in HIV and hepatitis C, and growth tied to those indications, as well as 11% sales growth for the company's cardiovascular drugs Letairis and Ranexa, lifted the company's third-quarter sales from $2.7 billion in 2013 to $5.97 billion this year. Similarly, Gilead's revenue has jumped from $7.76 billion during the first nine months of 2013 to an eye-popping $17.25 billion over the same period this year.

As a result, Gilead Sciences' balance sheet has improved significantly. Exiting the third quarter, Gilead had $7.7 billion in cash on the books, up from $2.57 billion last December. Even more impressive is that this growing cash hoardcomes after the company spent $5.8 billion in the third quarter buying back shares and settling stock warrants tied to previously retired convertible notes.

In addition to Gilead Science's soaring cash balance, the company's financial ratios also suggest that the company has the firepower to pay dividends.

Gilead's current ratio, which measures liquidity by taking a company's current assets (cash, cash equivalents, receivables, inventory) and dividing them by short-term liabilities (notes payable, current debt payments, payables, accrued expenses, taxes), is solid at 2.08. It should improve further over the coming months as sales continue to roll in.

Gilead Sciences' 58.6% operating margin over the past 12 months is the best it in its history. It could improve further as sales volume for new drugs such as Zydelig, a treatment for blood cancer, builds over the coming year.

The sales spurt also means the company's spending on day-to-day operations and drug development is tumbling as a percentage of revenue. Gilead Sciences' selling, general, and administrative expenses have fallen from more than 23% of revenue in 2005 to less than 13% over the past 12 months. The percentage of money allocated to R&D has dropped from 18% of sales in 2012 to 11.4%. Importantly, Gilead, though, isn't forgoing R&D investments that could result in future growth: the drop in percentage terms has come solely thanks to revenue growth. Over the past 12 months, management has plowed $2.3 billion into R&D, which is far more than its $1.25 billion run rate in 2012.

Why it probably won't pay a dividendGilead Sciences and other biotechs have shunned dividend payments in favor of funding research and development. Those projects are incredibly expensive --members of the industry trade association Pharmaceutical Research and Manufacturers of America spent roughly $51 billion on R&D last year alone-- yetmore than 90% of drugs fail to make it through clinical trials to commercialization.

The biotech industry's hit-and-miss nature encourages companies to stockpile cash that can be used for drug development or to partner with smaller emerging biotech companies with promising new approaches.

That model has arguably been very successful for Gilead Sciences. The company has leveraged money generated from its established and highly successful HIV drug franchise to fund research into next-generation treatments and to acquire new therapies. For example, the company's spending to develop and launch multi-drug combination HIV therapies like Complera and Stribild has boosted the company's sales by hundreds of millions of dollars per year. And Gilead's $11.2 billion acquisition of Pharmasset in 2012 was how Gilead got its hand's on Sovaldi in the first place.

Persistent questionsGilead Sciences' dominate position in its markets, along with its rapidly improving balance sheet, suggest the company could afford to pay a dividend, but that doesn't mean it will. Plenty of persistent questions could keep management from taking the step, including whether competitors will capture some of the company's market share in hepatitis C. Gilead Sciences will likely want to keep plenty of dry powder to develop next-generation HIV and kidney disease therapies. Also, given how quickly biotech moves, the company could go on a spending spree and acquire some promising upstarts instead. Additionally, while it's not uncommon for big companies to carry debt on their balance sheet, Gilead might decide to pay down those obligations. Since these factors could keep Gilead Sciences from paying a dividend, investors may find that -- for now at least -- they'll have to remain content with share repurchases.

The article Gilead Sciences Should Pay a Dividend, But It Won't originally appeared on Fool.com.

Todd Campbell owns shares of Gilead Sciences. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends Gilead Sciences. The Motley Fool owns shares of Gilead Sciences. 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.