Why A Merck Dividend Increase Could Be Forthcoming

About: Merck & Co Inc. (MRK)
by: Pat Racaniello
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Being interested in high dividend yields, Merck & Co. (NYSE:MRK) appealed to me when I bought it back in July 2005. At that time it appeared to be poised for some significant dividend growth. After all it was a giant in the pharmaceutical industry, and still is. The drugs are used in the treatment of cardiovascular ailments, hypertension, cholesterol lowering, anti-inflammatory, glaucoma, ulcers, Hepatitis, Parkinson's disease, and high blood pressure. Medications for domestic animals include drugs to treat for the control of parasites, and breeding problems encountered with livestock. What few investors know is that MRK is one of the world’s largest producers of vaccines. Vaccines are very difficult to produce as they require complex manufacturing procedures. It produces some 15 different vaccines used in the prevention of measles and mumps, to diseases never thought preventable, like shingles and cervical cancer.

My thinking back in 2005 was even if there were no increases I would reinvest the dividends and increase my share count, and the increased share count would lead to higher dividend payments to me. As most Seeking Alpha readers know, MRK has not increased its payout since 2005. I am now semi-retired and must start taking MRD (minimum required distributions). However, now could be the time for what I have been waiting to see…a dividend increase.

First let’s look at the numbers. MRK spent almost $11 billion on R&D in 2010; that’s almost 24% of 2010’s revenue. MRK's managers announced plans to slash R&D expense in 2011 to $8.3 billion. They are also continuing restructuring plans, which should save some $4.6 billion annually. Head count is expected to drop by 12%, as Schering-Plough becomes more fully integrated. Net profit margins have a 10-year average of close to 24%/year. Debt to capitalization is 22%, with total debt of $18.3 billion and cash assets of $13.98 billion. MRK earned $3.42/share for 2010, and $3.75 for 2011 appears extremely likely. And now that the Schering-Plough merger is complete results should continue to improve going forward. Look for $3.90 in 2012 on revenue of $47 billion. And, as I stated previously, payouts have been stuck at $1.52 annually since 2005, yet MRK is still yielding a healthy 4.7%. The 10-year average dividend payout ratio is 54%. Based on 2011’s earnings estimate of $3.75/share, that ratio has dropped considerably to some 40%. This leads me to believe an increase could very well be forthcoming in the next 6 months, especially now that earnings are beginning to show some momentum. Even if I am wrong about an increase, the yield at current prices remains hard to beat.

Disclosure: I am long MRK.