Is Amgen Inc.'s Dividend Sustainable?

By Markets Fool.com

Buying and holding dividend-paying stocks has proven to be a terrific strategy for long-term investors. Companies with the ability to raise their dividends over time can become compounding machines and provide shareholders with a reliable source of future income.

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The healthcare industry can be a great place to find dividend-paying companies.Healthcare spending tends to be recession-resistant, which allows for companies with strong competitive positions to continue to pay out healthy dividends, even if the economy catches a cold. In recent years, big-name biotechnology companies like Amgen and Gilead Sciences have initiated dividend payments, making them solid contenders for income-focused investors.

Amgen, in particular, is an intriguing name. The company has been growing its dividend quickly, raising it more than 182% since its first payment in 2011. This fast growth rate combined with a forward yield of 1.9% should put the company on any dividend-focused investor's radar.

But is Amgen's dividend sustainable?
When assessing a dividend's sustainability, I like to focus my analysis on a few key metrics: revenue, net income, free cash flow, and the cash payout ratio.

Profitability is important to consider in any dividend-payer because a sustainable dividend must be backed up by actual earnings. Amgen generated a huge $19.3 billion in revenue in 2014, and it managed to convert an impressive $5.1 billion of that revenue into net income. Better still, Amgen takes heavy depreciation and amortization charges and has moderate capital investments requirements. When combined, these factors helped the company generate $7.8 billion in free cash flow for the year, which is well above reported net income.

Even with the big 30% dividend increase the company announced this past December, the dividend will only consume $2.4 billion of cash for the year. This gives Amgen a cash payout ratio 31%, which, to this Fool, looks like a very sustainable number.

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However, with biotechs like Amgen, and indeed all companies, I like to go a bit beyond the numbers to determine the health of the business and just how sustainable its dividend truly is. Just like with pharmaceutical companies, investors need to pay attention to key drugs' patent expiration dates, competition, and the drug development pipeline to look for clues as to how stable revenue and profit generation will be in the future.

While Amgen has several commercialized compounds producing revenue, a mere three drugs (Neulasta, Enbrel, and Epogen) were responsible for generating almost 60% of 2014 sales. With that kind of revenue concentration, taking a deeper dive to understand the competitive landscape for these drugs is critical.

Neulasta,a blockbuster drug used to boost white blood cell count during chemotherapy, accounted for a huge 24% of 2014 revenue. Neulasta's patent is set to expire in October 2015, which could open the drug up to biosimilar competition. Apotex Corporation, a Canadian pharmaceutical manufacturer, announced in December 2014 that the FDA accepted a filing for a biosimilar version of Neulasta.

To combat this potential biosimilar threat, Amgen got innovative and announced in December 2014 that it has received FDA approval for the Neulasta Delivery Kit, which features an On-body injector.

The On-body injector will remove the need for patients to return to their doctor's office for a follow up injection, which Amgen is claiming will increase patient compliance and satisfaction. If this technology is well received by the medical community, it will allow the company to continue offering clinical differentiation from potential biosimilar threats. If the On-body injector proves successful, it is possible Amgen could replicate this strategy with other drugs in the future.

Enbrel, another blockbuster drug for treating rheumatoid arthritis, accounted for 24% of 2014 revenue. Enbrel had a key patent that was originally set to expire in October 2012, but Amgen was able to secure a second patent that extended the drug's useful life until as far out as 2029. Sales of this key compound grew an impressive 11% year over year, so this drug's near-term future continues to look promising.

Epogen, which treats anemia,was responsible for 11% of 2014 revenue. Epogen's patent is set to expire in May 2015, and Hospira has already announced that the FDA had accepted an application for a biosimilar version of Epogen. Hospira later followed up with another press release that showed positive clinical and safety data when comparing the biosimilar to Epogen. If Hospira's biosimilar gains approval, it could potentially put Epogen's near-term sales in jeopardy.

While the biosimilar market does present a near-term threat to Amgen, it also represents a potential long-termopportunity. Amgen has nine biosimilar products currently in development. One of these, a copycat of AbbVie's blockbuster autoimmune drug Humira,has completed a phase 3 study showing clinical efficacy and safety. Humira's patent is set to expire in 2016, and worldwide sales topped $12.5 billion over the past 12 months, meaning the opportunity to grab some of this market share, albeit at a lower price, is huge. In total, Amgen estimates that its nine biosimilar drugs in development will compete in markets with worldwide sales in excess of $52 billion.

Beyond the biosimilar opportunity, Amgen has a near-term pipeline that looks promising. Three drugs have already been submitted to the FDA for approval that treat a variety of diseases like dyslipidemia, chronic heart failure, and metastatic melanoma.

In addition, Amgen recently received approval for Blincyto, a drug designed to treat relapsed/refractory acute lymphocytic leukemia. While the worldwide market for the drug is only about 2,000 patients, Blincyto's $178,000 price tag could still bring in significant revenue from this small patient population.

Between the pending FDA approvals and the biosimilar opportunity, Amgen should be able to capture enough market share to plug the revenue holes left by its own drugs being disrupted.

Looking ahead, management is guiding for sales to hit $20.8 billion in 2015 and earnings per share to land between $9.05-$9.40. Between the blockbuster drugs already on the market and the pipeline of opportunity in front of the company, Amgen's dividend looks to be easily sustainable and could even be poised for significant growth ahead.

The article Is Amgen Inc.'s Dividend Sustainable? originally appeared on Fool.com.

Brian Feroldi has no position in any stocks 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.