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3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income

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GuruFocus.com
·8 min read
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- By Nathan Parsh

With the S&P 500 yielding an average of just 1.5%, investors seeking income might feel that there are few options available to them. This discussion will examine three pharmaceutical stocks that offer at least twice the yield of the market index. Each company's dividend has a very healthy payout ratio that should allow for future dividend growth, helping income investors to sleep well at night.


Even better, all three names are trading below their historical valuations and intrinsic values as calculated by GuruFocus.

Bristol-Myers Squibb

Bristol-Myers Squibb Co. (NYSE:BMY) has been in existence in some form since 1887. The current version of the company came to be following a merger in 1989. More recently, Bristol-Myers completed its $74 billion acquisition of Celgene Corp. on Nov. 20, 2019. The company's top grossing products include Eliquis, which prevents blood clots, Revlimid, which treats cancers such as multiple myeloma, and Opdivo, which treats cancers such as advanced renal carcinoma. Bristol-Myers has a market capitalization of $140.5 billion and generated sales of $42.5 billion in 2020.

The company raised its dividend 8.2% for the Feb. 1 payment. The company has now increased its dividend for 14 consecutive years. This is also Bristol-Myers' second consecutive year of offering a high single-digit raise. The company's dividend has a compound annual growth rate of just 3.6% over the last 10 years.

Using the annualized dividend of $1.96 and expected earnings per share for the year, Bristol-Myers has a projected payout ratio of just 26%. This compares very favorably to the 10-year average payout ratio of 77%. If achieved, this would be the stock's lowest payout ratio in at least a decade. Shares of Bristol-Myers currently yield 3.1%, slightly ahead of the yield of 2.8% that the stock has averaged since 2011.

Analysts surveyed by Yahoo Finance expect that Bristol-Myers will earn $7.47 in 2021. Using Monday's closing price of $63.38, the company has a forward price-earnings ratio of 8.5. Shares have had experienced a lot of volatility over the last decade as the average price-earnings ratio is above 22 since 2011. I've discussed previously that a valuation range of 13 to 15 times earnings is my target range for Bristol-Myers, which would imply tremendous upside potential from the current high single-digit price-earnings ratio.

GuruFocus also appears to believe the stock is undervalued as Bristol-Myers is trading below its intrinsic value. As a reminder, the GF Value is calculated using historical multiples, the company's past returns and growth and future estimates of business performance.

3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income
3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income

Bristol-Myers has a GF Value of $71.53. Using the current share price, the stock has a price-to-GF Value of 0.89. The stock receives a rating of modestly undervalued from GuruFocus. Reaching the GF Value implies a nearly 13% return from current levels. Total returns could reach the mid-double-digits once the dividend yield is factored in.

Bristol-Myers's acquisition of Celgene will augment the company's product portfolio and should provide additional growth in the coming years. As a result, the dividend payout ratio should continue to be on the low side. This should be music to the ears of shareholders who have grown accustomed to the company's minimal dividend increases for the better part of a decade. It is likely that the company will continue to offer higher-than-normal dividend growth going forward. Even better, the stock is trading below both my target valuation and the GF Value. I continue to believe that Bristol-Myers is undervalued and should be considered for purchase for those looking for exposure to the pharmaceutical sector.

Merck

With a market capitalization of $196 billion, Merck & Co. Inc. (NYSE:MRK) is one of the largest health care companies in the world. Merck's product portfolio includes Keytruda, which is used to treat a variety of cancers including melanoma and is one of best-selling drugs in the world, and Gardasil, a vaccine for HPV. The company had revenue of $48 billion last year.

Merck raised its dividend 6.6% for the Jan. 8 payment, giving the company a decade of dividend growth. Since 2011, the dividend has compounded at a rate of 4.5% per year, though growth has accelerated since 2018 as the company's business has shown much improvement.

Shares have an annualized dividend of $2.60, which results in a projected payout ratio of just under 40% for 2021. Merck's payout ratio has been pretty consistent over the last decade, usually between 40% and 50%. This year's expected payout ratio comes in at the low end of that range. Shares offer a yield of 3.4% today, which almost matches the 10-year average yield of 3.3%.

Wall Street analysts expect the company will earn $6.56 in 2021. With a recent closing price of $77.51, Merck has a forward price-earnings ratio of 11.8. Shares have a 10-year average valuation of 15.5 times earnings, giving the stock a steep discount to its historical price-earnings ratio.

Merck trades well below its GF Value.

3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income
3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income

With a GF Value of $88.90, Merck has a price-to-GF Value of 0.87 today. Merck is rated as modestly undervalued by GuruFocus. Achieving the GF Value would mean a 14.7% return. Combined with the dividend yield and total returns could approach the high double digits. As a result, Merck appears to offer the best total return potential of the names discussed in this article.

Merck, powered by Keytruda as it enjoys patent protection in major markets until at least the end of this decade, should continue to enjoy a growing business. This should provide for additional dividend growth in future years. Shares also trade below the long-term average valuation and the stock has the most upside relative to its GF Value of the companies discussed. For these reasons, Merck remains a strong buy.

Pfizer

Pfizer Inc. (NYSE:PFE) has undergone a significant transformation recently. Pfizer formed a joint venture with GlaxoSmithKline plc (NYSE:GSK) that includes the company's over-the-counter business. Pfizer owns approximately a third of the joint venture. The company also spun off its off patent, branded and generic medicines business, which was then merged with Mylan to form Viatris (NASDAQ:VTRS). Top products include Eliquis, which the company developed with Bristol-Myers, Ibrance, used to treat breast cancer, and Prevnar 13, used to prevent infection from certain bacteria. The company has annual revenues of almost $42 billion.

Shareholders received a 2.6% dividend increase for the March 5 payment. As a result, Pfizer has now increased its dividend for 11 consecutive years. Following a major acquisition in 2009, the company cut its dividend two consecutive years. However, the dividend has a compound annual growth rate of almost 6% since 2011. In total, Pfizer has raised its dividend in 52 out of the past 54 years.

The company's annualized dividend is $1.56. This results in a projected payout ratio of 47% for 2021, just below the 10-year average payout ratio of 48%. Like Merck, Pfizer's payout ratio has been rather consistent over the last decade, usually in a range of 40% to 50%. At 4.3%, Pfizer offers the highest yield of the three stocks discussed. For context, the stock has averaged a yield of 3.7% since 2011.

Pfizer is expected to earn $3.31 in 2021. The stock closed the most recent trading session at $36. Using estimates for the current year, shaves have a forward price-earnings ratio of 10.9. The company has an average multiple of almost 21 times earnings since 2012. I have stated previously that I have a target price-earnings range of 14 to 16 for the stock, which would have Pfizer trading much more in line with peers. Valuation could be a substantial tailwind to shareholder returns were the stock to trade with my target.

Pfizer currently trades below its GF Value.

3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income
3 Undervalued Pharma Stocks for Sleep-Well-at-Night Income

Shares have a GF Value of $38.68, which results in a price-to-GF Value of 0.93. This earns Pfizer a rating of fairly valued, but shareholders would see a 7.4% return if the stock were to reach its GF Value. Combined with the dividend and total returns could be in the low double digits.

Pfizer has made changes to its business model recently as it is now more focused on the faster-growing pharmaceutical segment as opposed to generic medicines and consumer products. Even with two dividend cuts, Pfizer's long-term dividend track record is impressive and the current yield is robust. The payout ratio is very reasonable and in line with the historical averages. Given its low valuation and high yield, Pfizer could be a good name to own at the current price.

Final thoughts

Finding yield and value can be tricky in today's market, but Bristol-Myers, Merck and Pfizer all have a dividend yield that is twice that of the S&P 500 and all trade below their long-term valuations and GF Values. Investors looking to own stocks that will allow them to sleep well at night could do very well owning any of these names.

Disclosure: The author maintains a long position in Pfizer.

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This article first appeared on GuruFocus.