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This May Be The Best Pharmaceutical Stock for Income Investors

Lisa Springer

As an income investor, I feel like I've hit the trifecta when I find a low-risk stock that also has consistent dividend growth and a fantastic yield. The high-quality dividend stocks I look for often get little respect from analysts.

That is precisely the situation for one great-yielding pharmaceutical stock in particular. Wall Street has no great fondness for this company, whose stock trades at a price-to-earnings (P/E) ratio of 11, a steep discount to its industry peers. For instance, GlaxoSmithKline (GSK), Merck (MRK) and Pfizer (PFE) have P/Es of 19, 24 and 15, respectively. And this company's current modest valuation comes on the heels of an 18% gain in its share price in the past 12 months.

With revenue of $28 billion last year, U.K.-based AstraZeneca (AZN) ranks among the world's top 10 pharmaceutical companies. AstraZeneca develops treatments for a wide variety of disorders and owns several of the world's top-selling drugs, including Atacand for hypertension, Crestor for cholesterol and Nexium for acid reflux. Those three blockbuster drugs accounted for $11.1 billion in revenue last year.

Some of Wall Street's criticism of this company is justified. In the past, AstraZeneca has failed to build a new-drug pipeline of sufficient strength to offset revenue declines from expiring patents on older drugs such as Seroquel. However, AstraZeneca isn't getting enough credit for what's in its current new-drug pipeline.

The company has 71 drug candidates in clinical development and another 13 that were recently approved, launched or filed for regulatory approval. In addition, AstraZeneca is partnering with Amgen (AMGN), the world's largest biotechnology company, to develop new drugs for inflammatory diseases. AstraZeneca is also collaborating with Bristol Myers Squibb (BMY) on new non-insulin treatments for diabetes.

A few months ago, AstraZeneca recruited a new CEO, Pascel Soriot, from Swiss drugmaker Roche Holdings (RHHBY) to lead the company's turnaround. Soriot is overseeing a restructuring to remove layers of bureaucracy, improve the productivity of research and development efforts and streamline the company's cost structure. This restructuring is expected to yield $1.6 billion in annual savings by 2014. Going forward, Soriot plans to supplement in-house R&D with additional collaborations and bolt-on acquisitions.

Not every aspect of the company's story is rosy. AstraZeneca is expecting several years of declining revenue before new products begin to re-energize its top line. The effect of the expiration of Seroquel's patent was apparent in AstraZeneca's 2012 financial results, as revenue fell 17% and earnings per share (EPS) declined 12%, to $6.41.

The downward trend continued in this year's first quarter. Revenue dropped 13% from the same quarter last year, to $6.4 billion, and EPS was 25% lower at $1.41. Analysts predict AstraZeneca will earn about $5.38 a share this year and $5.20 in 2014.

AstraZeneca expects revenue will gradually decline to $21 billion in the next five years as the full effect of patent expirations is absorbed.

Despite eroding revenue, AstraZeneca continues to generate formidable cash flow -- more than $7.6 billion in the past 12 months. That's important because dividends, acquisitions and EPS-enhancing share repurchases are paid from cash flow, and AstraZeneca has more than enough to fund all these strategies. The company also has a solid balance sheet that shows more than $8 billion in cash and debt of $10 billion, which represents only about 25% of capitalization.

In addition, AstraZeneca has a stellar record for paying dividends and a firm commitment to maintaining a progressive dividend policy. Since 2003, the dividend has grown fourfold. The dividend is covered more than twice by earnings, which eliminates any threat of a dividend cut.

In fact, AstraZeneca has not cut its dividend in more than a decade. The company aims to pay out at least half its earnings as dividends and to increase the dividend over time. The latest increase was 11% in March to an annualized rate of $3.80. The forward yield on AstraZeneca shares is an exceptional 7.4% -- the best yield in the pharmaceutical sector.

At a beta of only 0.6, AstraZeneca shares are also very low risk. (The 0.6 beta means that AstraZeneca's stock is 60% as volatile as the overall market.) AstraZeneca stock is also less volatile than the shares of its pharmaceutical industry competitors, which have an average beta of 0.8.

Risks to Consider: Investors should be aware of currency risk. AstraZeneca pays its dividend in British pounds, which means any increase in the exchange rate for the dollar relative to the pound reduces dividends for U.S. investors. There are no foreign tax issues however, since the United Kingdom doesn't withhold taxes on dividends paid to U.S. residents.

Action to Take --> At a P/E of 11, AstraZeneca shares are attractively priced for investors who want the high profits of drug development combined with the reduced risk of a large, diversified drug portfolio. Income investors should like the company's track record of dividend growth and rich yield. While AstraZeneca's return to growth will take time, investors can collect 7% while they wait.

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