The Pharma War - Who's The Best In Income? The Final Conclusion

Summary

• The main goal is to find the best pharmaceutical company for income.
• In the previous part I talked about financial strength.
• Today, I am going to talk about dividends and slightly about valuations. At the end I am going to reveal the winner.

Introduction To The Final Conclusion

In the previous part I mostly talked about financial strength of my four pharmaceutical companies which all seemed to be very strong. Moreover, their FCF's were dominant against their peers.

Those companies are very well known and established, moreover, they are mostly used to be income generators. Even though those are very reliable sources of income, I want to find the best one in this game.

Those companies are again:

Name	Price	Market Cap	Founded
Johnson and Johnson (JNJ)	$159.03	436.32B	1886
AbbVie (ABBV)	$107.94	187.25B	2013
Bristol-Myers Squibb (BMY)	$61.43	136.71B	1887
Pfizer (PFE)	$34.54	192.10B	1849

Today, I am going to talk about dividends and valuation. In the end of this part I am going to summarize results and conclude a possible winner, perhaps two.

Now, I will start with dividends.

Dividends

All companies mentioned above are very well known for their stable income that they can generate over the time. I am going to look at two payout ratios (EPS payout ratio and FCF payout ratio) where I put more weight (circa 0.7) on the FCF payout ratio, because FCF is the main free source of a company. At the EPS payout I am going to use diluted EPS. Then I am going to look at dividend growths, to be precise on 3y CAGR and 5y CAGR. Finally, I am going to predict future FCF growth and possible future FCF payout ratio.

Johnson & Johnson (JNJ)

JNJ is without doubts the longest dividend growth performer of this selection with 58 years of consecutive growth.

	2017	2018	2019	2021 (Jan. report)	2021	2022
Diluted EPS	$0.47	$5.61	$5.63	$5.51	$9.52	$10.29
EPS payout	688%	62%	65%	71%	42%	42%
FCF	$6.47	$6.79	$7.42	$7.55	$8.22	$8.80
FCF payout	51%	52%	50%	52%	49%	48%

As you can see above, there is a slight growth in EPS payout over the time. I would rather expect slight decrease for the next few years ahead. In 2017 was payout 688% mainly caused by huge tax expense. However, FCF payout ratio (as I mentioned, I put more weights to this indicator) is showing very stable data over that time period. Average EPS payout is around 66% (year 2017 excluded) and average FCF payout is around 51% where 2021 is showing  slight underperformance. It is caused by COVID-19 impact. 

3y and 5y dividend growths result represent 6.34% and 6.13% CAGR respectively which is almost in line with the recent growth of 6.1%. I believe this growth rate is sustainable in the foreseeable future.

Seeking Alpha assumes 2021 EPS of $9.52 and 2022 EPS of $10.29. Using dividend growth of 6.1% CAGR we would get for both years ahead payout ratio of 42% which seems to be under recent average. SA also assumes 2021 FCF growth of 9% and I assume that for 2022 it could be 7% (to be more conservative). We could see then FCF payout for 2021 and 2022, 49% and 48% respectively which is guiding us to decreasing trend. I believe that dividends of JNJ are very safe.

AbbVie (ABBV)

After the spin-off in 2013, AbbVie has remained its dividend streak with very impressive performance.

	2017	2018	2019	2020	2021	2022
Diluted EPS	$3.30	$3.66	$5.28	$2.72	$12.40	$13.79
EPS payout	77%	98%	80%	167%	42%	41%
FCF	$5.88	$8.27	$8.60	$10.03	$11.83	$13.25
FCF payout	43%	43%	49%	47%	44%	42%

As you can see above, there is a big difference between EPS payout and FCF payout. EPS payout over 80-90% is alarming for me and I would like to see it at least under 75% which I believe AbbVie eventually will achieve. Anyways, FCF payout is under very safe 50% over this time period with average of 45%. Even though, there is a slight growth recent 2 years, I think it still gives AbbVie plenty of room to continue to grow their dividends with high safety.

3y and 5y dividend growths are showing 19% and 18% CAGR respectively where recent growth is 10%. I believe that era of 15%+ growth is over, so I would suggest that 6% to 10% annual growth is more sustainable and expectable. With LOE of HUMIRA it would be prudent to initiate more share buybacks to limit massive payouts after 2023.

SA assumes AbbVie's EPS for 2021 and 2022 of $12.40 and $13.79 respectively. Using 8% dividend growth for 2021 and 2022 which I believe is more reasonable, we could see very healthy EPS payout ratio. SA assumes 2021 FCF growth of 25%, however, I use more conservative prediction of 18% for 2021 and 12% for 2022. That indicate that we could expect from AbbVie FCF payout ratio for 2021 and 2022 of 44% and 42% which I believe is somewhere in line with historical results. Even after LOE of HUMIRA I believe that dividends of AbbVie are safe.

Bristol Myers Squibb (BMY)

BMY represents a capable company that has done great decisions in recent years. Acquisitions of Celgene and MyoKardia put BMY to next level.

	2017	2018	2019	2020	2021	2022
Diluted EPS	$0.61	$3.01	$2.02	($3.99)	$7.48	$8.11
EPS payout	256%	53%	78%	N/A	26%	26%
FCF	$2.55	$3.73	$4.04	$5.89	$7.65	$9.18
FCF payout	62%	43%	41%	33%	26%	23%

As you can see above, BMY's EPS payouts look kind of shaky. 2017 EPS payout of 256% is extremely high and 2020 payout does not even exist because of loss of $3.99 caused by implement charges mentioned in the previous part. Even though, their EPS payouts look horrible, I focus on continuously decreasing strong FCF payout ratios where average is 45% which I believe is remarkable. Even stronger than AbbVie and JNJ. 

3y and 5y dividend growths represent 6% and 4.6% CAGR respectively which is not to high despite very low FCF payout. I believe that BMY has a plenty of space to start higher growths over the next few years. Management is probably aware of that, because recent dividend growth represents almost 10% and I guess it is sustainable and healthy growth.

SA assumes EPS for 2021 and 2022 of $7.48 and $8.11 respectively. I am using for the calculation of future dividends 10% dividend growth and by using it I get EPS payouts of 26% for both years ahead. I guess it represents significant difference between historical results. SA assumes 2021 FCF growth of 38%, but I will use more conservative growths of 30% for 2021 and 20% for 2022. That would represent possible future FCF payouts of 26% in 2021 and 23% in 2021 which seem to be very strong. Overall I believe that dividends of BMY are starting to be better and safer every year ahead. 

Pfizer (PFE)

Pfizer is a very well established company with nice and stable results over the time.

	2017	2018	2019	2020	2021	2022
Diluted EPS	$3.52	$1.87	$2.87	$1.71	$3.34	$3.07
EPS payout	36%	71%	49%	87%	47%	53%
FCF	$2.40	$2.29	$1.77	$2.06	$2.41	$2.60
FCF payout	53%	59%	81%	74%	64%	63%

It is fair to say that Pfizer's EPS payout is volatile over the time with growing trend, however, it is still somewhere in the safe zone. Even 87% payout gave them a little place to growth their dividends without any dangerousness. My picture of reliable payout is under 60% for both years ahead. Looking at FCF payout, I can say that the safe level was reached in 2017 and 2018. Last two years payouts went to the higher zone, which was still under 100%. I would like to see a drop to safe 60% again. With the vaccine cash inflow I believe it will decrease for let's say the next two years ahead. Covid-19 vaccine represents significant injection, that I am sure will support the current dividend growth.

3y and 5y dividend growths represent 6.06% and 6.35% respectively. I believe this growth is adequate to FCF payout and possible future growth of FCF. I believe that further growth will represent circa 5-6% annually. 

SA assumes EPS for 2021 and 2022 of $3.34 and $3.07 respectively. When I use future dividend growth if 5.5% (which is last year dividend growth), I get payout ratio 47% in 2021 and 53% in 2022 which is what I suggested in the first paragraph. SA assumes FCF growth in 2021 of 17%, which is reasonable including the Covid-19 vaccine cash injection. For 2022 I will use 8% growth. Using those growths, I get future possible FCF payouts of 64% in 2021 and 63% in 2022. Althought those predictions are higher than my envisioned 60%, I would consider that as positive change. Overall, Pfizer's dividend are the most riskiest in all of mentioned companies, however, I do believe they are still stable and could be considered as reliable.

Valuation

Valuation can give you a clue, if the exact company is cheap relatively to its peers and its own historical results. I use the table below to show you 10y median of P/E (data from GuruFocus), FWD P/E of exact companies and P/S. 

	10y median   P/E	FWD P/E	10y median P/S	FWD P/S
Johnson & Johnson	20.2x	16.7x	4.09x	4.55x
AbbVie	20.2x	8.7x	4.10x	3.44x
Bristol Myers Squibb	15.6x	8x	4.17x	2.92x
Pfizer	17.3x	10.3x	3.83x	3.12x
Average		10.9x		3.50x

It is quite interesting that 10y median of P/S shows almost similar results at all companies. I determine that the fair value by P/S is somewhere around 4x. As we can see, only JNJ seems to be overvalued. Comparing FWD P/S to FWD P/S average, Pfizer and Bristol Myers both look undervalued, AbbVie somewhere at the fair value and JNJ again overvalued.

FWD P/E average indicates 10.9x where AbbVie and Bristol Myers look undervalued, nevertheless, Pfizer looks fair valued and JNJ again overvalued. However, to compare all companies to their 10y median results, I see undervaluation even at JNJ.

I also want to compare also my personals fair prices based on DDM, DCF, dividend yield, P/S and P/E + Ben Graham's formula.

	Fair Price Interval	Average	Upside
Johnson & Johnson	$153 - $172	$156	(2%)
AbbVie	$122 - $149	$126	17%
Bristol Myers Squibb	$68 - $79	$73	21%
Pfizer	$34 - $44	$39	15%

Based on my personal fair prices, Pfizer, Bristol Myers and AbbVie look undervalued. JNJ looks to be fairly priced.

Choosing The Winner

I was thinking how to properly choose the "winner" and to be the somehow objective. I thought I could use dividend streak, however, AbbVie is a very young company (after spin-off with Abbott Laboratories (ABT)) and it cannot compete in this with a behemoth like JNJ, even if I could use Abbott's dividend streak included in AbbVie's streak. No!

I am going to compare financial strength form the last part. Then compare FCF payout ratios + future FCF payouts. All dividend growths. Long-term EPS growth (data used from YCharts, Zacks and Yahoo Finance) and finally the fair value. I believe using all these metrics I can properly find the winner.

Metric	The Winner
Financial Strength	Johnson & Johnson
Historical FCF payout ratio	AbbVie
Future FCF payout ratio	Bristol Myers Squibb
Dividend growths	AbbVie
LT EPS growth	Pfizer
Value	Bristol Myers Squibb

• In the financial strength the winner is clearly JNJ.
• In the historical FCF payout ratio is AbbVie the winner with average of 45%. Even though, Bristol Myers has shown same results I tend to choose AbbVie, because this company has more stable payout against the BMY which was in decreasing trend, but from much higher place than AbbVie.
• In Future FCF ratio the trophy goes to Bristol Myers with the absolutely lowest payout from all. If they would achieve those payouts I would be more than happy. If they would miss it by let's say 10%, it still would give them extremely safe levels of payouts.
• In dividend growths AbbVie did the best job. Even though, Bristol Myers has grown up their recent dividend by almost 10%, AbbVie has still the supreme growth.
• The most shocking thing for me is the winner of LT EPS growth. It is Pfizer by almost 0.5% difference against Bristol Myers. I believe this growth would be caused mainly by Covid-19 vaccine income. I did very well compare all results from YCharts, Zacks and Yahoo Finance and results are same again.
• Final metric is value and Bristol Myers wins undoubtedly. It represents higher upside to fair price and lowest fundamental valuation against its peers.

I expected just one winner and I got two. To be honest, I believe this is reasonable and truthful result. These two companies represent the best for the income in pharma industry.

Conclusion

For me, this analysis was not easy, as I had to compare lots of data, find the best results and still had to be as much objective as I could.

Those two companies are really great performers. JNJ still remains supreme dividend king and if you choose JNJ you won't regret it. Same with Pfizer, it is a mature company with very stable operations and I believe it is going to reward its shareholders for a very long time.

Pharmaceutical industry represents a defensive part of your portfolio with reliable source of income. Those who own it, will agree with me that buying companies like AbbVie or Bristol Myers represent a prudent diversification for your portfolio.

One last thing I would like to point out is that I happily own all of these companies and I am going to keep them for the foreseeable time.