Warning: This High-Yield Stock’s Dividend Could Be at Risk

Biotech stocks are not known as dividend payers. Very few pay any dividend. Amgen (Nasdaq: AMGN) is rare in that it has a 2% yield. I believe some day it will be a major dividend payer like some Big Pharma companies are today.

But there is another (little-known) biotech company that currently pays a 9% yield. It does not develop or sell drugs to fight cancer or any other diseases. Rather, it holds patents and collects royalties on those patents from companies that use the intellectual property to develop drugs.

[ad#Google Adsense 336×280-IA]PDL BioPharma (Nasdaq: PDLI) has been paying a $0.15 per share quarterly dividend since 2011.

Though I’m not sure how much longer that will continue.

First, a little history:

Things had been going fine for PDL BioPharma.

In fact, at one time, I rated the stock a “B” for dividend safety.

But in September, its auditor Ernst & Young quit with no reason given.

I immediately pulled my dividend safety rating as I stated that the company’s numbers could no longer be trusted.

Since then, the stock has continued to fall, pushing the dividend yield above 9%. Shortly after Ernst & Young resigned, PDL BioPharma hired PricewaterhouseCoopers.

When Ernst & Young quit, PDL BioPharma’s management stated that there were no disagreements over accounting practices.

There are many reasons why an auditor might quit. Accounting disagreements could be one of them. Not getting along with executives is another. There could also be something unethical going on, like a romantic relationship between the auditor’s staff and an employee of the client.

I’m not suggesting any of these things happened. I’m just pointing out that there are various causes for an auditor stepping away from a client – and not all of them point to fraud.

Since Ernst & Young quit, there has been no restatement of past quarter or yearly results. And, at this point, there does not appear to be any on the horizon.

But now we have a new concern.

A large chunk of PDL BioPharma’s revenue comes from one patent – the Queen et al. patent. These are antibody humanization patents that were responsible for 85% of the company’s revenue in the first quarter of the year. And next year, they stop producing revenue.

In fact, revenue is projected to be down by nearly two-thirds in 2016 – dropping from an expected $580 million to $232 million.

Wall Street doesn’t have a consensus estimate for cash flow. Over the past two years, free cash flow came in at a range of $270 million to $292 million. During those years, PDL BioPharma paid $84 million and $96 million in dividends, respectively – giving the company plenty of wiggle room in case it hit a rough year.

But that’s exactly what’s likely to happen in 2016. If cash flow is reduced by a similar amount to earnings, we’re looking at free cash flow of approximately $117 million. I estimate the company will pay about $99 million in dividends in 2016 for a payout ratio of 85%, which is above my comfort level.

Now, management declared the $0.15 per share dividend for each quarter this year. So I don’t expect the dividend to be cut in 2015. But unless PDL BioPharma gets some revenue-producing assets to make up for the Queen et al. patents quick, it’s going to be tough to sustain the dividend in or beyond 2016.

The company does have over $400 million in cash that it can deploy to pick up some assets, and I’m sure management will do whatever it can in the next year to do so. But with a revenue and cash flow drop expected next year, the dividend can hardly be considered a lock.

Additionally, until management comes out and tells us what happened with its previous auditor, I can’t help but worry that there’s a monster under the bed that could come out at any time.

So I’m going to penalize the stock for that as well.

Things could change with the addition of new assets that will produce revenue and cash flow.

But until PDL BioPharma replaces the lost revenue, the dividend is not safe.

Dividend Safety Rating: D

If you have a stock whose dividend safety you’d like me to analyze, leave the ticker symbol in the comments section below.

Good investing,

Marc

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Source: Wealthy Retirement