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Summary

  • The healthy buffer in cash flows should allow the company to continue dividend growth.
  • Average annual growth of 3% over the last five years has been negatively impacted by the dividend freeze.
  • Focus on more profitable segments will allow the company to enhance its cash flows.

Merck & Co (NYSE:MRK) is a global health care company that delivers health solutions through its prescribed medicines, vaccines, biological therapies, animal health and consumer care products, which it markets directly and through its joint ventures. Recently, the revenues have been declining for the company due to some challenges faced by the company, discussed later in this article. Companies in the healthcare sector are usually good dividend payers, and despite freezing dividends for about seven years (2004-2011), Merck still remains one of the better dividend payers in the sector. In this article, we will be discussing the future prospects and the dividend growth prospects along with the cash flows of the company.

Dividend Growth

The industry average yield is 3.2%, indicating that the dividend yields are high in this sector. Merck's dividend remained stagnant from year 2004 to 2011 - during the same period, the company spent a substantial amount on the Schering-Plough merger. However, the company increased its dividend by 10.5% in 2012, which was followed by another small increase of 2.3% in the following year. Currently, the company pays an annual dividend of $1.76 per share, yielding 3.1%. During the last year, the company distributed cash dividends of $5.27 billion. Moreover, the company also bought back shares worth $6.5 billion, which takes the total cash returned to shareholders to approximately $11 billion.

The payout ratio based on free cash flows for Merck holds a decent position compared to its industry peers, mentioned in the table below. The total dividends paid over the last year were $5.27 billion, with free cash flows for the same period standing at $10.11 billion - the payout ratio for Merck is at around 52%. The comparison of Merck with other industry peers such as Pfizer (NYSE:PFE) and GlaxoSmithKline (NYSE:GSK) is given in the table below.

Dividend per share

Average growth in five years

Dividends paid (Billions)

Free cash flows (Billions)

Payout Ratio

Merck

$1.76

3%

$5.27

$10.11

52%

Pfizer

$1.04

5%

$6.58

$16.3

40%

GSK

$3

7%

$6.10

$9.15

67%

Source: Morningstar and SEC Filings

Pfizer has a lower payout ratio compared with Merck, but GSK's payout ratio is substantially higher than Merck. Merck grew its operational cash flows by 16% in the last year and decreased the capital spending by 21% during the same period, which resulted in a significant increase in free cash flows. However, the average annual dividend growth rate of the company is poor compared to the other two peers mentioned in the table, mainly because of the dividend freeze.

Future Prospects

During the last two years, Merck has suffered considerable decline in revenues due to unsatisfactory results of some of its products. Therefore, the company has decided to focus on profitable products with high growth prospects in the future. Following this, in January 2014, Merck announced to sell the company's consumer products division, which only reported $1.9 billion in sales during the last year, representing a mere 4% of the company's overall sales volume. The sale of this unit can bring Merck about $10 billion, which will give us the price-to-sales multiple of 5.2, considerably higher than the industry average of 3.7. However, as some of the major players of the industry are interested in the division, Merck might be able to get a good price.

This decision will move the company's focus towards more profitable product line of therapeutic products such as diabetes and cancer drugs - with the best-selling diabetes drug "Januvia" which represented 11% of the total pharmaceutical sales volume in the last year. With this strategy of shedding consumer brands division, focusing on current profitable products and improving the R&D efforts; we believe Merck will be able to increase its profits over the next few quarters.

The company is facing some challenges in maintaining its intellectual property rights in India, where the government is trying to lower the health costs by copying certain drugs related to diabetes, HIV and cancer treatment. The company is also working on developing new drugs. One such drug is MK-3475, which targets the cancer treatment. According to the trials, nearly 41% of the patients experienced improvement indicating 81% progress in their life expectancy. In addition to MK-3475, there are a number of drugs moving forward in the pipeline that could have a considerable impact on the company earnings in the coming years.

Conclusion

Merck has not been the best dividend payer in the sector; however, the growth in dividends over the last two years has been impressive. As the company is focusing on the high-margin areas, we believe the cash flows will be enhanced in the future. Current payout ratio gives Merck considerable room to further grow its dividends. Merck is a good pick for the investors looking for income.

Source: Is Merck A Good Dividend Pick?