As a dividend growth investor, I mainly look for companies with a long track record of growing dividends. In my latest article, I analyzed Herc Rentals (HRI) that just initiated its dividend. In this article, I will look at a company that only formed as an independent company three months ago, initiated a dividend, and has a lot to offer after the spin-off.
Six months ago I analyzed Merck (MRK) and I mentioned the spin-off of Organon (NYSE:OGN). The company assumed some debt and some assets mainly in the business of women's health, biosimilars, and some of Merck's established brands. I believe that the company is interesting for further research as it combines spin-off with dividends.
I will analyze the company using the graph below, which represents my methodology for analyzing dividend growth stocks. I am using the same methodology to make it easier for me to compare analyzed stocks. I will look into the company's fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it's a good investment.
(Graph made by author)
According to Seeking Alpha's company overview, Organon, a science-based pharmaceutical company, develops and delivers health solutions through a portfolio of prescription therapies within women’s health, biosimilars, and established brands. The company sells its products primarily to drug wholesalers and retailers, hospitals, government agencies, and managed health care providers.
The company has no meaningful history for us to rely on and understand the trends when it comes to revenues and earnings. We can only assume the future growth rate of both these important metrics. The company explains in the latest earning call that 2021 will be an inflection year and that it will increase R&D spending later.
The company believes that it can maintain EBITDA margins above 30% after R&D spending. According to Seeking Alpha, the consensus of analysts believe that the company will grow slowly in the coming years. This is in line with the company's guidance for low single digits growth. I believe that the most important aspect is the high level of uncertainty.
(Source: Seeking Alpha)
The company has announced its first-ever dividend of $0.28 per share. The dividend will be paid quarterly thus the annual dividend payment stands at $1.12 per share. The current yield is very enticing at just over 3% with the payout ratio being extremely safe below 20%. I expect Organon to keep increasing its dividend in the coming years as it is part of its capital allocation plan.
The company hasn't announced any other measures to return capital to shareholders besides the dividends. However, I wouldn't be surprised if in the coming years we will see a buyback program initiated. It makes perfect sense due to the current valuation which seems to be extremely attractive, and the buybacks will be very effective.
Valuation is where Organon shines. The company is new, and analysts and investors alike are not sure how to evaluate it with little information. However, when we look at the company's guidance and analysts' estimates for EPS of $6.12 in 2021, the current forward P/E stands at 5.5, which is extremely cheap compared to the company in the pharmaceuticals business.
Even under the conservative assumption of little to no growth the company is trading for an extremely low valuation. The graph below from Fastgraphs.com shows a similar story. Look how deep the price line is. The company is trading for a valuation that is almost impossible to find these days, and I believe there is room for expansion.
There is very little historical data when it comes to Organon's fundamentals. What we do have is the company's action. We see a dividend, and a wide portfolio with guidance for slow growth in the short term. These stable fundamentals come with an extremely low valuation that leaves investors with an impressive margin of safety.
Spin-off companies tend to outperform the broader market. Many articles have found it, and the main reason is the same lack of information that makes most investors run away. I believe that this is an opportunity for investors as eventually, the company's valuation will expand. The company holds a broad and diverse portfolio of established brands on the one hand together with newer products in the women's health field and biosimilars.
(Source: Q2 Presentation)
Humira is another huge opportunity for Organon. It is a blockbuster drug produced by AbbVie (ABBV). With sales of over $20 billion in 2020 alone, Humira is getting closer and closer to its U.S patent cliff in 2023. Organon sells its biosimilar drug Hadlima, and it was approved for sale in Australia and Canada. Once the company can compete in the United States, it will have some track record in other markets.
Women's health and Nexplanon are another growth opportunity. With the pandemic recovery, the company believes that there will be a higher demand for birth control. Nexplanon has the potential to become a leading product since it's easy to insert and remove, and has long efficacy. The company sees an opportunity to more than double the annual sales.
(Source: Q2 Presentation)
Competition is probably the largest risk for Organon. The company is not a mega cap like Merck anymore. It is a medium cap company with less pricing power, weaker logistics, etc, and it has to adjust to the new position. Every product that the company offers can be subject to competition from the large pharma companies, and competing from this position is a challenge.
In addition, the pharmaceutical business is very capital intensive. It requires massive investments that only come to fruition years later. The company acknowledges the fact that it will have to increase its R&D budget in the coming years to keep its pipeline productive, increase revenues and replace revenues of drugs that deal with a patent cliff.
The third risk is the company's position with such little data. Research has indeed shown that most of the times spin-off companies outperform the market. However, it doesn't change the fact that investors have very little data about the company. Investing with little data is always a risk even when there is plenty of margin of safety just like in this case.
Organon is a solid company with stable fundamentals a newly initiated dividend. The company offers these stable fundamentals together with an extremely attractive valuation. In addition, the company has several growth opportunities both through P/E expansion and sales growth. At the same time, the company is dealing with some risks that are very common in this sector.
I believe that investors who invest in Organon will be rewarded in the long term. It sometimes takes several years until a spin-off company achieves its "correct" valuation, as investors require more data. I believe that investors in Organon, will enjoy capital appreciation and in the meantime, they can enjoy the 3% dividend that will grow annually.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of ABBV either through stock ownership, options, or other derivatives. 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.