Big pharma isn't the first industry many investors envision when dreaming of the big profits to be made from health care stocks. While blockbuster drugs can propel the top big pharma companies to massive profits, these broad behemoths can't match the exciting growth potential and immediate investor return of an up-and-coming biotech firm breaking out into its own.
For dividend investors, however, big pharma's unmatched in health care. Offering the stability of a wide drug portfolio and sizable revenue, top pharmaceutical firms are enticing picks for income investors. Merck(NYSE:MRK) stock's 3.8% dividend yields stands out as one of the larger offerings in the sector, but is this the stock income investors can't afford to pass up?
Big payout, little flexibility
That 3.8% dividend with Merck stock is a big one: The yield tops many of its competitors in big pharma, but it does so at a cost. The dividend costs the firm an 87% dividend payout ratio, which is a tough pill to swallow for a company struggling with patent cliff-related revenue drops. There's little room for Merck to increase its dividend with that substantial of a payout.
Merck's history also isn't kind for those income investors hoping for dividend raises any time soon. While the firm has raised its dividend twice since late 2011, the company previously hadn't raised it since mid-2004. Even though Merck had delivered a number of dividend increases before that point, that's a long time to keep income investors waiting and a wary sign about future increases.
Fortunately, Merck's vast portfolio of drugs is big enough to offer stability for risk-averse investors. But even that safety blanket may be disappearing. Merck's earnings miss in its most recent quarter, coupled with patent expirations of major drugs, could be a sign of instability to come -- and risk to threaten that tasty dividend -- at this Big Pharma player.
Drugs under fire
A stable, safe stock is a dividend investor's friend, but Merck's most recent quarterly miss indicated anything but safety. Revenue fell 4% below expectations this past quarter, and the company's announcement of a $15 billion buyback plan looks more like a desperation move to keep shareholders temporarily happy, rather than a long-term plan for the good of the company.
Those falling sales are a victim of the patent cliff, which has already claimed sales from former megablockbuster drug Singulair. Singulair's hardly the only Merck drug facing a tough road ahead, however: Nasonex, which pulled in $1.2 billion last year, and Zetia, a cardiovascular bright spot for Merck with more than $2.5 billion in sales in 2012, both face patent expirations in the next five years.
If Merck can't find suitable future blockbusters to replace these and other threatened drugs, declining revenues will wipe out all hope of dividend increases in the near future. Unfortunately, some of Merck's brightest stars of tomorrow are facing pressure of their own.
Merck's diabetes drug pair, Januvia and Janumet, paid off in a big way for investors last year with more than $5.7 billion in sales. However, Januvia's sales dipped surprisingly in the first quarter, and more headaches could be on the way. Johnson & Johnson's (NYSE:JNJ) newly approved diabetes treatment, Invokana, has already shown some benefits over Januvia in certain clinical trials and could be poised to take a bite out of Merck's sales. Along with the FDA's investigation into pancreatitis concerns for Januvia patients, Merck's star drug isn't having its best time right now. Any threat to its billions of dollars in sales could drastically hurt this firm's future.
Even Merck's developmental drugs are under fire. Osteoperosis drug odanacatib has been touted as a potential future blockbuster for the company, but Merck delayed the therapy's regulatory filing. Odanacatib might not be approved until 2015 now, missing out on a change to take advantage of rival drug patent expirations. Eli Lilly's (NYSE:LLY) standout osteoporosis drugs Evista and Forteo, which combined for more than $2 billion in sales last year, will soon take a hit when Evista loses exclusivity next year.
None of these adverse conditions are enough to threaten a dividend decrease from Merck, an event that's unthinkable for this blue chip stock. Still, with revenue under fire and a lowered sales outlook for the full year, Merck's not the safest pick among top dividend payers in big pharma. Its inordinately high payout ratio -- particularly when a safer rival like Pfizer (NYSE:PFE) offers a similar dividend yield at a much smaller ratio -- and recent lack of dividend increases make Merck stock a dividend that investors should stay clear of. There are better, safer, and more attractive picks in health care for income investors than this struggling titan.
Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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