The second selection for the newly launched Inflation-Protected Income Growth Portfolio is generic medication powerhouse Teva Pharmaceutical (NYSE:TEVA). As the largest generic drugmaker in the world , the company is well positioned to survive and thrive in a cash-constrained environment for medical care. With its 2011 purchase of Cephalon, Teva also enhanced its branded drug business and pipeline, making higher (though riskier and more variable) returns possible.
With its history of rising dividends that stretches back at least a dozen years, the company's shareholder-friendly behavior predates the Bush dividend tax cuts and thus will likely not be derailed if they expire. With its focus on generics, even if the critics of Obamacare are correct that the legislation will stifle medical innovation, there will still be a demand for Teva's core products. And with a respectably low payout ratio of 32%, it has considerable coverage even if things do go bad.
Why it's worth owning in the iPIG Portfolio
To earn a spot in the portfolio, a company has to pass a series of tests related to its dividends, its balance sheet and valuation, and how it fits from a portfolio diversification perspective.
- Payment: The company's annual dividend currently sits at $1.034 a share, a yield of nearly 2.5% based on Thursday's closing price. That dividend is reduced by a 20% Israeli withholding tax, resulting in a net yield for American investors of right around 2%.
- Growth history: The company has paid higher dividends every year since 2000. Unlike many companies, though, it does not pay the same dividend amount every quarter. That means you can't project a precise payment amount, but as long as the trend remains positive, it should be an easy enough issue to deal with.
- Reason to believe the growth can continue: With a payout ratio of 32%, the company retains nearly 70% of its income to reinvest for future growth. That low payout ratio also means the dividend can continue to move up for several years, even if the business stagnates.
Balance sheet and valuation:
- Balance sheet: A debt-to-equity ratio of 0.6 indicates that the company does use debt, but hasn't over-leveraged itself to the point where a financial hiccup would derail it.
- Valuation: By a discounted cash flow analysis, the company looks to be worth around $37.2 billion, making its recent market price of $36.4 billion look reasonable. Of course, there's some geopolitical risk involved; the company is headquartered in Israel, so the ongoing regional strife hits very close to home.
- The only other pick currently scheduled for the portfolio is an industrial conglomerate, making this pharmaceutical company a reasonable choice from a diversification perspective.
What are the risks?
As an Israeli company, Teva is headquartered in a very unstable part of the world. Fortunately, it has a strong global geographic footprint that buffers the overall company, even if the worst were to happen to its headquarters. Also, because it's headquartered in Israel, there is foreign currency exchange rate risk built into owning shares. That said, Israel's shekel has been pretty stable versus the U.S. dollar over the past five years, and the company's strong U.S. business does provide something of a natural hedge, as well.
Additionally, branded pharmaceutical giant Pfizer (NYSE:PFE) started betting big on generics when it became clear that its patented Lipitor franchise wouldn't last it forever. If anyone has the industry knowhow and size to leverage scale right alongside Teva, it's Pfizer. And now that Teva has gotten bigger in the branded-drugs space, it runs greater risks (and costs) of a post-launch failure and recall. Just ask Merck (NYSE:MRK) how difficult and expensive the aftermath of its Vioxx debacle was.
What comes next?
When the Fool's disclosure policy allows, I plan to buy Teva stock for the Inflation-Protected Income Growth portfolio, as long as its share price remains below $44. I expect to invest around $1,500 in the selection, giving it a 5% allocation in the portfolio, with 90% of the portfolio still remaining cash. Watch my article feed for details of the next pick, coming soon.
Also, to score the performance of this pick, I'm maintaining my previously existing outperform CAPScall on the stock at Motley Fool CAPS, putting my All-Star ranking on the line along with the plan to invest cold, hard cash.