With Washington once again looking at ways to negotiate lower prescription drug prices, the Health Care Select Sector SPDR Fund (XLV -0.96%) is lagging the S&P 500 year to date, up 17% this year compared with the index's 21%.
Two of the top 10 holdings in the Health Care SPDR Fund are Merck (MRK -0.03%) and Pfizer (PFE -0.35%). Let's take a look at why these two stocks offer both value and safe dividend yields, and why income investors should consider buying them in September.
As one of the leading oncology companies in the world, Merck is firing on all cylinders and securing additional regulatory approvals across the globe for its blockbuster oncology drug Keytruda. The market arguably views this as a double-edged sword, however; Merck's stock is down 5% year-to-date as the S&P 500 has steadily climbed higher.
That's because, despite the company's success in getting a number of extra indications approved for Keytruda this year, the drug's patents are set to expire in the U.S. and the EU in 2028. Since Keytruda contributed $8.08 billion, or 36.7%, of Merck's $22.03 billion in first-half revenue (up from 34% of the $19.64 billion in total first-half revenue last year), the market is skeptical that Merck can adequately prepare for the looming drop.
But I believe the market is missing the fact that Merck is more than just Keytruda.
Merck's vaccine and animal health segments grew their first-half revenue by a combined 18.4%, from $5.73 billion last year ($3.42 billion in vaccine revenue and $2.31 billion in animal health revenue) to $6.79 billion this year ($3.90 billion in vaccine revenue and $2.89 billion in animal health revenue).
With four of the vaccines in Merck's pipeline in phase 2 clinical trials and another currently under regulatory review, Merck should be able to sustain the momentum in its vaccine segment through this decade. This should allow Merck to remain a key player in the growing vaccine market, which market research company Reports and Data expects will compound at 7.3% annually from $42 billion in 2020 to nearly $74 billion in revenue by 2028.
And while investors wait for the vaccine and animal health segments to soften the blow of Keytruda's patent expirations in 2028, they can collect a safe 3.5% yield.
How can I be sure of Merck's dividend safety?
For one, Merck's dividend payout ratio for this year is set to be very sustainable. It should be hovering in the high-40% range based on current guidance of $5.47-$5.57 in earnings per share (EPS) against dividends per share of just $2.60.
Second, Merck's interest coverage ratio of 12 in the first half of this year ($4.70 billion in earnings before interest and taxes versus $381 million in net interest expense) suggests that the company could withstand a significant decline in its EBIT and still cover the costs of its debt.
Despite Merck's steady operating fundamentals, the company appears to be fairly priced for long-term investors. Merck's current price-to-sales ratio of 3.83 is essentially in line with its 13-year median of 3.82, which is what makes the stock a good buy for dividend seekers.
Pfizer has essentially matched the S&P 500's 21% year-to-date gains. This has in large part been due to the unparalleled commercial success of its COVID-19 vaccine, known as Comirnaty, which was co-developed with Germany's BioNTech (BNTX -1.78%) and fully approved by the U.S. Food and Drug Administration (FDA) for those ages 16 and up last month.
Pfizer expects that it will deliver 2.1 billion doses of Comirnaty this year, which should generate $33.5 billion in revenue after its revenue split with BioNTech. This revenue forecast is up significantly from just the first quarter of this year, when Pfizer was forecasting 1.6 billion in doses provided and $26 billion in net revenue.
While Comirnaty will be responsible for most of the growth in Pfizer's revenue this year -- from $41.9 billion last year to the $78 billion to $80 billion forecasted for 2021 -- Pfizer has other products that should contribute to growth going forward. Two drugs that have done so year to date are Vyndaqel and Vyndamax, both of which approved by the FDA to treat a rare and serious heart condition known as transthyretin amyloid cardiomyopathy (ATTR-CM). Because more doctors and patients have become aware of this treatment in the past year or so, the two drugs' combined first-half revenue nearly doubled from $508 million last year to $953 million this year.
Looking out over the next several years, a non-COVID vaccine that could potentially be a blockbuster for Pfizer as soon as 2023 or 2024 is its respiratory syncytial virus (RSV) vaccine candidate, known as RSVpreF. If RSVpreF is able to replicate its Phase 2 clinical results in its ongoing Phase 3 clinical trial, the drug could fetch upwards of $2 billion in annual revenue for Pfizer.
Not only does Pfizer have a healthy existing product portfolio and pipeline, but the company's balance sheet also remains a strength. That's because Pfizer's interest coverage ratio through the first half of this year was 19 ($12.29 billion in EBIT versus $639 million in net interest expenses). In other words, even a sharp decline in Pfizer's EBIT likely wouldn't jeopardize the company's ability to service its debt.
Pfizer's adjusted EPS payout ratio will be in the high-30% range this year based on its current guidance of $3.95-$4.05 in adjusted EPS and dividend per share obligation of $1.56. This signals that the current 3.4% dividend yield is safe, and the payout should also grow in the years ahead.