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Forget Merck & Co. Inc.: Here Are 2 Better Dividend Stocks

By George Budwell – Feb 2, 2016 at 7:44AM

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These familiar names are better options for income investors.

Image source: Flickr via user Steven Depolo.

Big Pharma stocks have tended to attract significant interest among dividend investors because of their proven ability to generate enormous free cash flows -- even in turbulent economic environments.

Merck & Co. (MRK -0.69%) in particular has frequently been a top target for income-seeking investors due to its strong brand recognition, and management's commitment to consistently raising the dividend over the past decade. Even so, the blue chip drugmakers GlaxoSmithKline (GSK -1.84%) and Johnson & Johnson (JNJ -0.61%) are probably better options for dividend investors than Merck at this stage. Here's why. 

Looking beyond the numbers...
At first glance, Merck's dividend appears to stack up favorably against Glaxo and J&J. According to S&P Capital IQ, for instance, Merck's free cash flows over the past year were stronger than Glaxo's, and the drugmaker's trailing-12-month payout ratio is markedly lower than J&J's. 

CompanyPayout RatioDividend YieldTrailing-12-Month FCF2016 Projected Revenue Growth
Merck  47.7%  3.6% $7 billion  1.9%
Johnson & Johnson  55.6%  3.1%  $18.5 billion

 2.5%

GlaxoSmithKline  39%  5.5%  $4.6 billion  3.5%

However, Merck has a slight disadvantage in terms of its projected revenue growth this year. Despite strong currency headwinds, J&J is still on expected to grow its top line by 2.5% in 2016 as a result of its growing pharmaceutical business, headlined by star oncology drugs like Imbruvica and Zytiga.

Looking further out, J&J's immense clinical pipeline has the potential to produce between 20 to 25 new blockbuster products over the next decade, according to the company's CEO Alex Gorsky. That kind of major new drug production simply has no equivalent in the pharma industry right now. Meanwhile, J&J also boasts a robust consumer products segment with cash cows like Tylenol and Band-Aid that should provide reliable revenue for years to come.

Glaxo's top line is also projected to exceed Merck's this year, in part because of the company's rebounding respiratory franchise that's finally starting to see a nice uptick in market share for key new medicines like Anoro and Breo Ellipta:

Image source: GlaxoSmithKline.

In fact, Glaxo's management believes the sales of these newer respiratory products should be strong enough going forward to offset any losses from declining sales of its former best-selling asthma medicine Advair. 

Besides its recovering respiratory franchise, Glaxo's joint venture in HIV known as "ViiV Healthcare" and its newly acquired vaccine business from Novartis are also expected to help return the drugmaker to growth this year. That's why Glaxo's management recently announced that the company will maintain its top-flight dividend payout at current levels through at least 2017.

Sweetening the pot further, Glaxo also plans on paying a special dividend of approximately $0.29 per share, at current exchange rates, this year, showing management's commitment to rewarding shareholders. 

Merck's anemic top-line growth hints at deeper problems
Another major reason I think J&J and Glaxo are better buys for dividend investors is because Merck has oriented its overall business model toward highly competitive markets with poor long-term outlooks. After buying Cubist Pharmaceuticals and Idenix, for instance, Merck deepened its portfolio of novel antibiotic and hepatitis C products.

The problem is that antibiotics tend to have comparatively short shelf lives due to the rapid evolution of their target pathogens. And on the hepatitis C front, Merck is entering a space that is already chock-full of top-notch drugs and blue chip biotech competitors. That's not to say that Merck can't make a go of it in hepatitis C, but it may have a hard time expanding beyond niche areas of the market such as particularly difficult-to-treat patients.

Tying it all together
Picking dividend stocks that can provide sustainable income for years to come is tricky. Based on its current financial metrics, for example, Merck appears to be a great dividend stock to sock away in your portfolio. If you peel away these superficial layers, though, the drugmaker fails to match up to some of its closest peers like J&J and Glaxo.

After all, J&J's proven ability to innovate in the pharmaceutical space has helped it build out one of the strongest product portfolios in the business. The company's long-term prospects in pharma are no less impressive because of its commitment to bringing novel medicines to patients with few treatment options. Put simply, J&J is not in the business of developing "me-too" drugs with fuzzy competitive moats; but rather, the company's goal is to bring game-changing treatments to market that set the pace in many areas. 

Glaxo, for its part, is finally starting to turn the corner after a long battle with falling revenues, pricing pressures, and the patent cliff. The drugmaker's revival in the high dollar respiratory space, along with its growing footprints in the HIV and vaccine markets, seems to give the company a great shot at returning to growth in 2016.  

All told, I believe J&J and Glaxo offer better prospects for income-seeking investors because their overall business models sport more favorable long-term growth prospects, despite the fact that these companies are facing unique competitive threats of their own. 

George Budwell has no position in any stocks mentioned. The Motley Fool recommends 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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