Is AstraZeneca plc A Safe Dividend Investment?

Ever since Pfizer’s takeover approach, shares in AstraZeneca (LSE: AZN) (NYSE: AZN.US) seem puffed up.

At a share price of 4351p the firm’s forward P/E rating stands at just under 18 for 2015, which seems high for a company expected to show a decline in earnings of 7% that year. The dividend yield is about 3.9%, which isn’t high enough for a slow- or no-growing company.

The biggest threat to an investment in AstraZeneca for income now is valuation — what’s the point in harvesting dividends if a downward valuation rerating could erase our total returns at a stroke?

The American effect that hasn’t happened

Even recent news that the US government is implementing tough new rules on corporate “inversion” deals, aimed at making tax-avoidance transactions less desirable, hasn’t dented AstraZeneca’s share price much. We might think that making it less appealing for American companies to takeover British ones would blow much of the froth from AstraZeneca’s valuation, yet the shares are only down a smidgeon.

Meanwhile, London-listed peer GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) trades at a P/E rating of just over 14 for 2015 with a better dividend yield over 5.9%. On top of that, City analysts predict earnings’ growth of 5% at GlaxoSmithKline for 2015, beating AstraZeneca to an earnings’ turnaround hands down. That sounds like a much better investment proposition for dividend income, at least as far as immediate valuation is concerned.

Dividend-paying capability

Yet AstraZeneca’s dividend-paying credentials seem sound. The firm has a record of producing hefty cash flow that looks quite stable and a history of raising its dividend payout every year:

The pharmaceutical industry enjoys stable demand from customers that need to repeat-purchase, which is why AstraZeneca’s cash flow looks constant. It takes cash to pay the dividend, so strong cash flow is essential for supporting a progressive dividend policy at any firm.

However, the big pharmaceutical companies face a lot of competition from me-too firms that swoop into the market as soon as big-selling drugs come out of patent protection, and from firms that develop their own alternative formulas to treat medical conditions.

The situation on competition has hit the big pharmaceutical firms hard in recent years, which is why earnings have been down. AstraZeneca is working hard to develop new drugs to replace lost takings from previous high earners, but the development process is long and torturous.

What now?

Whether or not we believe that AstraZeneca will score more blockbusting hits in the future, it’s a jam-tomorrow proposition until it actually happens. In the meantime, AstraZeneca’s valuation needs to cool to pique my desire to own the shares — wake me up when the dividend yield exceeds 5%.

Perhaps you disagree and see attraction in AstraZeneca now? Ultimately, we all need to make our own investing decisions, but an informed decision often pays best, which implies doing our own research.