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Merck Will Hold Steady on Div Increase Despite Flat Revenue Growth

- By Sangara Narayanan

From the price to sales point of view, Merck (MRK) is one of the most expensive healthcare stocks, trading at nearly 4.5 times sales, more than you need to pay for Pfizer (PFE) or Novartis (NVS). Merck is possibly the only pharma major to see its stock price almost steadily rise in the last five years. It has more than doubled its price during that time, from under $30 in August 2011 to above $60 in August 2016.


There are several reasons why the company, as well as its stock, has performed well while the overall segment has been battered with patent cliffs and companies out-bidding each other in the fight for promising drugs. The pharma landscape has become extremely competitive, with generics and biosimilars adding more pain to the mix. Merck has somehow managed to keep swimming against the tide.

With a near 3% yield, Merck's stock looks like an extremely attractive dividend pay as well. Let's take a closer look to see why - despite the stock doubling in the last five years - the yield still remains so high.

Revenue Growth

For any dividend investor who wants to hold a stock long term, revenue growth has to be the first criteria to analyze. If the company is not able to grow at a stable rate, what will happen is that a few years down the road dividend growth will stagnate. If that continues, at some point it will be cut altogether.

Procter & Gamble (PG) is a good example of a company that is now standing at the first hurdle. With revenue growth slowing down, dividend growth has already stagnated for the company. If someone told you ten years ago that the great P&G would someday slow down its dividend growth to a crawl, you would have never believed it. But unfortunately that day has arrived, and the root cause is revenue slowdown.

But Merck is not immune to revenue hits. The company's 2015 sales declined by 6% to reach $39.5 billion on negative impact from foreign exchange, while acquisitions and divestitures also dented their numbers for the year. The company expects its 2016 revenues to come in at between $39.1 billion and $40.1 billion, which means the company expects to post modest growth or decline for the year.

Currency headwinds have been impacting Merck's revenue this year as well. The company reported second quarter sales of $9.8 billion, an increase of 1%, despite currency impacting the numbers by -2%. Pharmaceutical revenues increased by 2% and animal health increased by 7%. With $8.7 billion in sales coming from pharma, Merck's growth is entirely dependent on how this division performs.

Balance Sheet and Cash flow

At the end of the second quarter, Merck had $11.8 billion cash on hand and long-term debt of $23.64 billion. In the first six months of the year, the company paid $2.579 billion in dividends. In fiscal 2015, Merck's dividend payment amounted to $5.117 billion with an operating cash flow of $12.421 billion, while free cash flow for the year reached $11.13 billion.

Considering the cash flow position and the net debt level, Merck's dividends look safe and with the company expecting to keep its revenue stable for the year, their ability to pay dividends in the short to medium term looks secure.

Though the company is trading at 16.3 times forward earnings and 4.5 times its sales, the 2.92% yield is way too attractive to let go of.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.

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This article first appeared on GuruFocus.