A Sad Reality: 3 of Healthcare's Top 5 Dividends Probably Aren't Sustainable

Source: Flickr user Sean McMenemy.

Dividend stocks are the cornerstone of many of the best retirement portfolios. Not only do dividends provide a payment that shareholders in a stock can take to the bank, but when reinvested, these dividends' incredible compounding gains can mean the difference between simply retiring and retiring comfortably.

Dividends serve other purposes as well. Dividends, especially dividends that rise over many years, act as a waving flag to investors that a company's business model is strong enough to stand the test of time. Lastly, the willingness of a company to pay a dividend signifies that management holds the interests of its shareholders high on its "to-do" list.

A sad reality One area where dividends are relatively few and far between is the healthcare sector. If you really think about it, this shouldn't be too big of a surprise, since healthcare companies are usually better off reinvesting in their pipeline and spending a little more on research and development than in paying a dividend. Since healthcare stocks are valued primarily on the future sales potential of the current product portfolio and their pipeline, it's a smart move to reinvest back into the business.

Despite this dearth of dividends in healthcare, there are six companies currently paying out in excess of 4%, or a level that's at least double what theS&P 500 is currently averaging. The unfortunate reality, at least as I view it now, is that three of healthcare's top six highest dividend yield stocks don't have a sustainable long-term payout.

Theravance : 4.2% yieldTheravance is an interesting case, as it split last year into two separate companies -- a royalty-based company (Theravance) and a predominantly development-based company (Theravance Biopharma). The move was designed to increase revenue clarity for investors as well as give investors the choice of investing in a higher or potentially slower growth entity.

The unfortunate thing is Theravance helped finance this separation, as well as some of its ongoing operations and its dividend, with a $450 million debt offering. I can't emphasize enough how potentially dangerous it can be for a company to finance a dividend with a debt offering!

Breo Ellipta. Source: Theravance.

Theravance's $0.25 per quarter payment is based on the idea that its co-developed COPD products with GlaxoSmithKline will result in a number of potential blockbusters. Unfortunately, the duo's COPD drugs, Breo Ellipta and Anoro Ellipta, have trickled out of the gate rather than blasted off. Breo's extrapolated run rate based on its latest quarterly results is only $102.4 million per year, while Anoro brought in just $1.8 million in Q3 2014.

In short, unless these COPD products see a dramatic turnaround, then Theravance, the fifth-highest yield in healthcare, won't be paying a dividend for much longer. There's little justification to $115 million per year in dividend cash outflows when the current cash inflow is practically nonexistent.

GlaxoSmithKline: 5.5% yieldAs noted above, GlaxoSmithKline hasn't fared well in recent months because of the weak launch of both of its co-developed, long-lasting COPD drugs. There's hope that Breo Ellipta possibly being approved for asthma could reinvigorate sales, but both it and Theravance have struggled to get insurance coverage on their new inhaled therapies.

Source: Flickr user Steven Depolo.

However, GlaxoSmithKline has an even bigger monkey on its back than Theravance. The reason GlaxoSmithKline is the leading company in respiratory sales is because of Advair (known as Seretide outside the United States), a drug responsible for more than $8 billion in annual sales. Advair lost patent exclusivity years ago, but the Food and Drug Administration didn't lay out testing guidelines that generic drug developers could follow until late 2013. This essentially started the sands of time against Advair. By roughly 2016 there should be a generic (and considerably cheaper) version of Advair on U.S. pharmacy shelves, which will evaporate a significant chunk of Glaxo's $8 billion-plus in sales.

Considering this upcoming hole in Glaxo's top and bottom lines, Wall Street is forecasting that the company's full-year EPS will drop from $3.51 in 2013 to an estimated $1.81 in 2017. For context, GlaxoSmithKline's extrapolated dividend payout is currently $2.45. Unless GlaxoSmithKline's COPD and asthma products see a dramatic (and I mean dramatic) turnaround, then the second-highest dividend yield in healthcare is likely to be cut.

PDL BioPharma : 7.9% yieldLastly we have PDL BioPharma, a biotech company that earns its keep by collecting royalty payments on its antibody humanization patents.

Initially, PDL's business model looks very profitable. Because of its low cost structure (remember, there's no expensive ongoing R&D here), PDL BioPharma is capable of producing some of the sector's best margins. In fact, in the third quarter, PDL saw its revenue surge by a whopping 64% to $164.6 million.

Source: PDL BioPharma.

But, there's a big concern with biotech royalties: They're based on branded drugs that only have a finite period of exclusivity. This means PDL either needs to spend big money to purchase additional royalty streams, or the business model will simply wind down. Because PDL pays out a vast majority of its profits to shareholders, it'll potentially need to sell common stock and dilute existing shareholders in order to raise enough cash to purchase a royalty stream.

Don't get me wrong; some of PDL's royalty assets are relatively new and should continue to deliver royalty payments throughout the remainder of the decade, if not beyond. But assets like Tysabri are nearing their sunset in terms of patent exclusivity, and they could result in PDL BioPharma chopping its dividend payment sooner rather than later.

The article A Sad Reality: 3 of Healthcare's Top 5 Dividends Probably Aren't Sustainable originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.