Merck (MRK) is a buy for the total return investor that also wants some income as the world economy grows. Merck is one of the largest drug companies in the world. MRK is a conservative investment since it is also a defensive company if the market turns down.
Merck will be reviewed using The Good Business Portfolio guidelines. The company has steady growth and has the cash it uses to increase the dividends each year. Merck is increasing the illnesses that a particular drug can treat which gives that drug strong increased sales.
When I scanned the five-year chart, Merck has a good chart going up and to the right in a strong slope for the last 1.5 years. Before this upswing MRK was flat.
Fundamentals of Merck will be reviewed on the following topics below.
- The Good Business Portfolio Guidelines
- Total Return and Yearly Dividend
- Last Quarter's Earnings
- Company Business
- Recent Portfolio Changes
I use a set of guidelines that I codified over the last few years to review the companies in The Good Business Portfolio (my portfolio) and other companies that I am reviewing. For a complete set of the guidelines, please see my article "The Good Business Portfolio: Update to Guidelines, August 2018." These guidelines provide me with a balanced portfolio of income, defensive, total return, and growing companies that hopefully keeps me ahead of the Dow average.
Good Business Portfolio Guidelines
Merck passes 11 of 11 Good Business Portfolio Guidelines, a good score (a good score is 10 or 11). These guidelines are only used to filter companies to be considered in the portfolio. Some of the points brought out by the guidelines are shown below.
- Merck does meet my dividend guideline of having dividends increase for 8 of the last ten years and having a minimum of 1% yield, with 8 years of increasing dividends and a 2.7% yield. Merck is, therefore, a good choice for the dividend income investor. The five-year average payout ratio is high, at 83%. After paying the dividend, this leaves cash remaining for increasing the business of the company.
- I have a capitalization guideline where the capitalization must be greater than $10 Billion. MRK easily passes this guideline. MRK is a large-cap company with a capitalization of $204 Billion. Merck 2019 projected cash flow at $11 Billion is good, allowing the company to have the means for company growth and increasing dividends each year.
- I also require the CAGR going forward to be able to cover my yearly expenses and my RMD with a CAGR of 7%. My dividends provide 3.3% of the portfolio as income, and I need 1.9% more for a yearly distribution of 5.2% plus an inflation cushion of 1.8%. The three-year forward S&P CFRA CAGR of 12% easily exceeds my guideline requirement. This good future growth for Merck can continue its uptrend, benefiting from the continued strong growth in the worldwide economy.
- My total return guideline is that total return must be greater than the Dow's total return over my test period. MRK passes this guideline since their total return is 79.26%, more than the Dow's total return of 38.28%. Looking back five years, $10,000 invested five years ago would now be worth over $16,000 today. This makes Merck a good investment for the total return investor looking back and has future growth as the United States economy continues to grow.
- One of my guidelines is that the S&P rating must be three stars or better. MRK's S&P CFRA rating is four stars or buy with a target price to $88, passing the guideline. MRK's price is presently 8% below the target. MRK is under the target price at present and has a low forward PE of 17, making MRK a fair investment at this entry point. If you are a long-term investor who wants good steady increasing dividend income and future total return growth, you may want to buy this company.
- One of my guidelines is whether I would buy the whole company if I could. The answer is yes. The total return is great, and the above-average growing dividend makes MRK a good business to own for income and future growth. The Good Business Portfolio likes to embrace all kinds of investment styles but concentrates on buying businesses that can be understood, makes a fair profit, invests profits back into the business and also generates a good income stream. Most of all, what makes MRK interesting is the potential long-term growth of their drug pipeline as the working population and economy increases. MRK gives you an increasing dividend for the dividend investor and a positive total return.
Total Return and Yearly Dividend
The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Merck beats against the Dow baseline in my 54-month test compared to the Dow average. I chose the 54 month test period (starting January 1, 2015, and ending to date) because it includes the great year of 2017, and other years that had a fair and bad performance. The good total return of 79.26% makes Merck a good investment for the total return investor. MRK has an above average dividend yield of 2.7% and has had increases for 8 years, making a good choice for the dividend growth investor. The dividend is estimated to be increased in October 2019 to $0.62/Qtr. up from $0.55/Qtr. or a 13% increase.
The Dow's 54-month total return baseline is 38.28%
Click to enlarge
Last Quarter's Earnings
For the last quarter on April 30, 2019, Merck reported earnings that beat expected at $1.22, compared to last year at $1.05. Total revenue was higher at $10.8 Billion more than a year ago by 7.76% year over year and beat expected by $363.63 Million. This was a good report with bottom line beating expected and the top line increasing with a good increase compared to last year. The next earnings report will be out late July 2019 and is expected to be $1.11 compared to last year at $1.05 a gain.
The graphic below shows the 1st quarter summary results.
Source: MRK 1st quarter 2019 Earnings call slides
Merck is one of the largest pharmaceutical companies in the United States and foreign countries.
As per excepts from Reuters:
Merck & Co is a global healthcare company. The Company offers health solutions through its prescription medicines, vaccines, biologic therapies, and animal health products.
It operates through four segments: Pharmaceutical, Animal Health, Healthcare Services, and Alliances.
The Company's Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders.
Overall, Merck International is a good business with 12% CAGR projected growth as the United States and foreign economies grow going forward, with the increasing demand for MRK's products. The good dividend income brings you cash as we continue to see further growth as the world economy grows.
The Fed has kept interest rates low for some years, and on December 19, 2018, they raised the base rate of 0.25%, which was expected. I believe that they will go slow in 2019, which should help keep the economy on a growth path. If infrastructure spending can be increased, this will even increase the United States growth going forward with better economics for the consumer. At the March 20 meeting, the Fed lowered United States GDP projection for 2019 which they said is getting to neutral on the economy, projecting no rate increases for 2019. The Fed meeting Statement was a wait and see and a bit more dovish than the last meeting. At the May 1 meeting, they did not raise rates and kept them the same. In early June the Fed chairman hinted of a possible rate reduction.
From April 30, 2019, earnings call Ken Frazier (Chief Executive Officer and Chairman) said:
We had a very strong start in 2019. And we are seeing our fundamental strategy of investing thoughtfully in R&D involving the science payoff. Our current portfolio of assets continues to drive strong growth, and we are working to ensure that we capture the near-term opportunities in front of us to maintain this momentum while planning for the next generation of treatments.
Our first quarter performance with double-digit year-over-year sales and EPS growth are the results of portfolio and operational strengths driven by oncology, vaccines, and select hospitals and specialty products. We’re confident that products within these areas, including KEYTRUDA, LYNPARZA, LENVIMA, GARDASIL, BRIDION, and others together with our Animal Health franchise will lead to strong growth over the coming years.
Our performance in this first quarter also speaks to our success globally as we've received a number of additional approvals and launched new products in various markets around the world. Our international business, which represented nearly 60% of our sales this quarter, has strong momentum. And we believe that we've only scratched the surface in terms of the opportunity in key markets such as China, where we see significant growth.
We foresee a stream of additional approvals from our current portfolio of products across markets globally, and we will look to maximize these opportunities powered by our commercial team's proven ability to execute. In parallel, we are also focused on advancing our promising pipeline and continuing to augment our internal research and development efforts with external innovation. We are excited by the prospect of our pipeline, which includes potential new treatments and vaccines, oncology, HIV, and many other areas of significant and ongoing unmet needs.
This shows the feelings of top management for the continued growth of the Merck business and shareholder return with an increase in future growth. MRK has good products, and the growth will continue as new indications are added to existing drugs.
The graphic below shows the high growth that happens as indications are approved for existing drugs.
Source: MRK 1st quarter 2019 Earnings call slides
Source: MRK 1st quarter 2019 Earnings call slides
Merck is a good investment choice for the total return investor looking back, and the above-average dividend yield makes MRK an interesting choice for the dividend income investor. Merck will not be bought by The Good Business Portfolio. The portfolio already has Johnson & Johnson (JNJ), a similar company in the portfolio. If you want a solid growing dividend income and recent good total return in the drug business, MRK may be the right investment for you to take a look at.
Recent Portfolio Changes
I intend to watch the earnings reports for the companies in the portfolio and may finally decide to trim my high flyers that are over 8% of the portfolio so I can invest in good companies on my buy list.
- On May 24, I trimmed the position of Home Depot (HD) from 9.40% of the portfolio to 9.00%. I like HD, but it is getting too high a percentage in the portfolio. HD will be kept at 9% of the portfolio.
- On May 6, I added to the position of Digital Reality Trust (DLR) from 3.40% of the portfolio to 3.60%. I will add slowly to this position as available cash allows and want to get it to 4% of the portfolio, a full position.
- On April 22, I sold all of the Hewlett Packard (HPQ) position. The company's last earnings report was poor, and future growth looks weak at 2%. It's time to sell HPQ for a better business.
- On March 22, I added to the position of Simulations Plus (SLP) from 0.45% of the portfolio to 0.60%. I will add slowly to this position as available cash allows.
- On March 13, I increased the position of Realty Income Corp. (O) to 0.85%. I needed a bit more steady monthly income.
- On March 12, I closed out the position of Arconic Inc. (ARNC). I only have one more commodity play, Freeport-McMoRan (FCX), that I think will go up over time. The dividend was just cut, and forward growth is under par.
The five companies comprising the largest percentage of the portfolio are: Johnson & Johnson at 8.0% of the portfolio, the Eaton Vance Enhanced Equity Income Fund II (EOS) at 8.0% of the portfolio, Home Depot at 9.2% of the portfolio, Omega Health Investors (OHI) at 8.4% of the portfolio, and Boeing (BA) at 13.1% of the portfolio. Therefore, BA, EOS, JNJ, OHI, and HD are now in trim position, but I am letting them run a bit since they are great companies.
Boeing is going to be pressed to 15% of the portfolio because of it being cash positive on 787 deferred plane costs at $316 Million in the first quarter of 2017, an increase from the fourth quarter. The first quarter earnings for 2018 were unbelievable at $3.64 compared to expected at $2.64. Farnborough Air Show sales in dollar value just beat out Airbus (OTCPK:EADSF) by about $6 Billion, and both companies had a great number of orders. Boeing received an order for 18 more KC-46A planes. The second quarter 2018 earnings beat expectations by $0.06 at $3.33, but a good report was hurt by a write off expense on the KC-46, which has started delivery in 2019. Eight KC-46A tankers have been delivered YTD for 2019. Boeing has dropped in the last 6 weeks because of the second 737 Max-8 crash, and I look at this as an opportunity to buy BA at a reasonable price. This is just my opinion. An FAA representative said on May 23 that the 737 Max could be flying again by late June, which would be great.
JNJ will be pressed to 9% of the portfolio because of its defensive nature in this post-BREXIT world. Earnings in the last quarter beat on the top and bottom line, and Mr. Market did nothing. JNJ has just increased the dividend to $0.95/Qtr., which is 57 years in a row of increases. JNJ is not a trading stock but a hold forever; it is now a strong buy as the healthcare sector remains under pressure.
The total return for the Good Business Portfolio is ahead of the Dow average YTD by 5.64%, which is a nice gain above the market for the portfolio. Each quarter after the earnings season, I write an article giving a complete portfolio list and performance, the latest article is titled “The Good Business Portfolio: 2019 1st Quarter Earnings and Performance Review.” Become a real-time follower, and you will get each quarter's performance after the next earnings season is over.
Disclosure: I am/we are long BA, JNJ, HD, OHI, MO, IR, DLR, GE, PM, PEP, TXN, MRK, AMT,O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Of course, this is not a recommendation to buy or sell, and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account, and the opinions of the companies are my own.