Merck and Altria: Opposites Providing Steady Growing Revenues (NYSE:MO)

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Written by Nick Ackerman. This article was originally published to Cash Builder Opportunities members on March 8, 2022.

Review two stocks today that might seem more opposite than they really are. Merck (New York Stock Exchange: MRK) is a healthcare company, and Altria (NYSE: MO) is a tobacco company. In fact, the drug that contributes the most to MRK’s revenue is Keytruda. A drug that “can treat certain cancers by working with your immune system”. This has also been one of their main growth drivers.

One of the main cancers for which Keytruda has been shown to be effective is non-small cell lung cancer (NSCLC). One of the causes is smoking. Cigarettes are Altria’s number one product, although they have been and must diversify in the future. For now, they continue to have strong pricing power, but smoking rates have declined. MRK will not meet Keytruda’s patent expiration until 2028.

This is why I would generally view these two companies primarily as opposites. However, both of their business models predict fairly steady cash flows. This, in turn, means that they steadily increase dividends year after year. MO has a much longer history of dividend increases, but MRK might get there one day.

In addition to the dividend growth that has been achieved, these two stocks have quite attractive valuations. This is despite the outperformance of the broader market, as measured by the S&P 500 SPDR ETF (SPY) on a YTD basis. This is another of the positives for stable companies like these; they tend to be defensive in times of uncertainty.

MO, MRK and SPY

Y-Charts

Altria Group, Inc. (MO)

Start with MO as it is a favorite of income investors. To be completely honest, I haven’t covered this stock although it is in the Core Income Builder portfolio. At the end of the day, there’s just not much I can say that hasn’t been said and written about a million times before. That’s how strong and consistent its dividend has been.

The title has increased its dividend for 52 years on a regular basis. This was accomplished with the latest increase of 4.7% to $0.90 from $0.86. However, the dividend chart does not necessarily show this. You have to adjust for the Kraft Foods spin-off and the Philip Morris (PM) spin-off in 2007 and 2008, respectively.

MO Dividend history

MO Dividend History (Altria)

The 4.7% increase investors received was quite generous, but slow compared to what shareholders received. The dividend growth rate over 3 years is 5.47%, and that over 10 years is even more generous at 8.34%.

MO dividend growth

MO Dividend Growth (looking for Alpha)

In 2021, MO recorded EPS of $4.61; this was up from 2020 EPS of $4.36 or an increase of approximately 5.73%. Growing the dividend a little slower than earnings growth means it could provide a cushion for years when growth might be a bit more limited. This also frees them up for further redemptions, which we’ll cover below.

On their last earnings call, they had mentioned that they thought they would deliver between $4.79 and $4.93 for BPA. This would equate to an adjusted diluted EPS of 4-7%. We are looking at a payout ratio of 76.36% for the dividend at current levels. It might seem higher for other traditional stocks, but if you think of MO as a utility, it might not seem so high. They remain attached to a growing dividend; their own target is a dividend payout ratio of around 80%.

The healthy takeovers that were completed in 2021 appear to be compensating for somewhat slower growth. 2020 itself saw no redemptions. That being said, this was the only year without a buyback of outstanding shares in the past decade. To find another year without redemption, one would have to go back to 2009 and 2010.

Graphic

Y-Charts

We have already seen above that the stock is holding up well on a YTD basis. It actually offered a stock price return of 8.57%. It’s a bit of a bonus when the focus is on the current dividend yield of 6.81%. The stock is still well below the all-time highs it reached in 2017. Based on the current forward PE, the stock looks attractively valued at just 10.90. Earnings over the next few years are also expected to grow around that 4-7% level, analysts say. Revenues appear to be lagging a bit as analysts are predicting mostly flat earnings.

The cigarette industry is definitely not in a growth phase, so that makes a lot of sense. MO himself mentions that “our vision by 2030 is to responsibly lead the transition of adult smokers to a smoke-free future”. To do this, they plan to continue investing and innovating in their smoke-free products. However, another key driver is the cannabis market which has grown rapidly as states legalize and/or decriminalize. I think that makes a lot of sense, given the business they’re already in.

Several years ago, they bought out a significant 45% share of the Cronos Group. Then there was speculation that they might buy the rest they don’t already own. So far, Cronos doesn’t seem to be performing as well as they would have hoped.

As further explained in Note 6, in preparing our financial statements for the year ended December 31, 2021, we concluded that our equity-accounted investment in Cronos fell below its carrying amount and that there was insufficient evidence to conclude that the impairment was temporary. As a result, we recorded a pre-tax non-cash impairment charge of $205 million on (income) losses from equity investments in our Consolidated Statement of Income (Loss) for the year ended December 31, 2021. If Cronos is unable to successfully execute its business plans and strategies and the fair value of our investment in Cronos continues to decline, this could result in additional impairments, which could have a material adverse effect on our financial condition or our consolidated results.

Maybe if Altria could buy the business, they would be more successful if it was more integrated. This will be something to watch over time.

Merck & Co., Inc. (MRK)

MRK may not be as popular as MO, but it certainly has a lot of merits. Some of the main selling points are that the stock has increased its dividend, attractive yield and decent valuation. He still has a respectable following of nearly 181.5,000 subscribers via Seeking Alpha as well. MO has nearly 216.5k for context.

MRK would have had an even longer dividend growth streak than the last 12 years, but they froze their dividend from around 2004 to 2011. After that, they provided more moderate increases. It’s really in the last few years that they’ve become more aggressive in increasing their payouts to investors. Below are the quarterly dividends, according to the Investor Relations website.

MRK Dividend History

MRK (Merck) dividend history

The latest dividend increased by 6.2% from a quarterly amount of $0.65 to $0.69. It was less than inflation, which we would generally want to take into account. To help offset some of that lack of growth, I think, the stock price is holding up relatively well while we’ve been experiencing significant volatility. . The forward yield is 3.55%, and they’re posting a payout ratio of just 45.85%, meaning they have plenty of room to grow from here.

We again see that dividend growth this year has been a slowdown compared to earlier annualized periods. We have the last 3 years showing a dividend growth rate of 11.21%. Over the past 10 years, it has provided a growth rate of 5.78%, so the most previous boost has overcome this hurdle.

MRK Dividend Growth

MRK Dividend Growth (looking for Alpha)

For the full year 2021, GAAP EPS from continuing operations was $4.86, non-GAAP EPS was $6.02. In 2021, MRK spun off Organon & Co (OGN). The spin-off was to offload the slower-growing women’s health side of their business. They expect EPS and revenue growth to accelerate with what’s left in the business. It was a pretty big part of their business before, so getting a dividend increase despite losing part of their business was pretty impressive.

OGN posted that its revenue for the year 2021 was $6.3 billion, MRK itself posted $48.7 billion. This was significantly helped by a 17% increase, with Keytruda sales up 20%. Keytruda accounts for $17.2 billion in revenue to provide additional context on how important this drug is to them. To be clear, Molnupiravir sales were also included in this figure. This represented $952 million in sales. It’s their COVID-19 pill that will likely become less relevant over time.

For MRK, in 2022, they provided guidance in their earnings release:

Expects full-year 2022 GAAP EPS to be between $5.76 and $5.91; Expects non-GAAP EPS to be between $7.12 and $7.27

Turnover should grow by 15 to 18%. If they can pull off non-GAAP EPS at the midpoint of $7.20, we’re looking at a payout ratio of just 38.33%. An expected 19.6% jump in non-GAAP EPS is quite impressive. This advice also takes into account sales of molnupiravir.

One of the best parts of MRK is that it’s also attractively priced. Based on the forward PE of 10.62, this makes it cheaper than many of its peers. This could be due to the uncertainty of molnupiravir after it emerged that it might not be as effective as it was originally shown. Although it still looks like they were able to ship a lot of the drugs around the world. They expect molnupiravir to generate $5-6 billion in sales for 2022. That might be a bit of a high expectation and it’s something to watch.

Conclusion

Merck and Altria may seem like positive companies at first glance. However, for an income investor, they are not that far apart. Both have provided steady and steady increases in dividends to investors. Both are apparently priced attractively at the moment, and both offer quite defensive positioning in times of uncertainty. Their last dividend increases were lower than where inflation came in, but I think consistency is key to future growth year after year.

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