Published by Bob Ciura on April 19th, 2017
Investors can count on the health care sector for dividends.
Pfizer (PFE) and Teva Pharmaceuticals (TEVA) have dividend yields of 3.8% and 4.2%, respectively.
Their dividend track records are spotty: Pfizer cut its dividend by 50% in 2009, and Teva hasn’t raised its dividend since 2015.
That said, Pfizer it has raised its dividend each year since the cut.
With a few more years, it will become a Dividend Achiever, a group of 265 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
And, their high yields are attractive. The S&P 500 Index on average has just a 2% dividend yield.
This article will compare-and-contrast Pfizer, a company trying to fight off generic competition, with Teva, the largest generics manufacturer in the world.
Business Overview
Both Pfizer and Teva operate primarily in pharmaceutical drugs.
Some health care companies, such as Johnson & Johnson (JNJ), have large medical devices and/or consumer health franchises, for diversification.
Pfizer and Teva are almost entirely focused on pharmaceuticals. Pfizer has a consumer health care products segment, but it comprises just 7% of its annual revenue.
Pfizer operates two reporting segments:
- Innovative Health (55% of revenue)
- Essential Health (45% of revenue)
Source: 2016 Earnings Presentation, page 14
The Innovative Health segment is Pfizer’s most important business. It includes the company’s core pharmaceutical drugs Ibrance, Eliquis, and Xtandi.
Organic revenue increased 2% last year in this segment.
Teva is a manufacturer of generic pharmaceuticals. It has a diversified business model, with a majority of annual revenue derived from generics.
Source: 4Q 2016 Earnings Presentation, page 27
Pfizer’s revenue rose 8% last year. Operational revenue, excluding one-time impacts and foreign exchange fluctuations, increased 11% in 2016.
Adjusted earnings-per-share increased 9% for the year, to $2.40.
Pfizer performed well last year in both of its operating segments. Innovative Health and Essential Health both grew revenue by 11% in 2016.
Some of the company’s leading contributors were internal medicine and oncology, which grew by 17% and 56% last year, respectively.
On the other hand, Teva had a mixed year.
Source: 4Q 2016 Earnings Presentation, page 24
Revenue increased 11%, thanks in large part to the acquisition. But free cash flow fell 11%, due to significantly higher expenses.
Teva decided to invest more in building its own pharmaceutical pipeline last year. R&D expenses increased 38% from 2015. In addition, selling and marketing expense rose 11%.
This is because Teva is facing generic pressure for one of its own products, Copaxone. Two competing drugs went to market in the U.S. in 2017.
Teva sees the potential for $1.0-$1.3 billion in lost Copaxone revenue this year, from generic competition.
Growth Prospects
Teva’s growth is primarily the result of acquisition. Last year, Teva acquired Actavis Generics from Allergan plc (AGN).
This was a huge deal—Teva paid $40.5 billion for Actavis. As a result, Teva is now the world’s largest generics manufacturer.
The acquisition is expected to be a meaningful catalyst for Teva. Actavis was the primary reason for Teva’s 11% revenue growth last year.
Going forward, the acquisition will help give the company greater leverage over its customers. It can help expand the company’s negotiating power with governments and health insurance companies.
Teva expects full-year 2017 revenue of $23.8-$24.5 billion, which would represent 9%-12% growth from 2015.
Adjusted earnings-per-share are expected to be $4.90-$5.30, representing a 1% decline at the midpoint of guidance.
The expected decline in earnings reflects another year of higher investment spending for Teva.
Generics in general are seeing strong demand, due to high prices of branded products. Pfizer is one of the Big Pharma companies most impacted by drug price deflation.
Several years ago, Pfizer lost patent exclusivity for its cholesterol drug Lipitor, which at one point brought in more than $10 billion in annual sales all by itself.
In response, Pfizer pursued many acquisitions, and invested in research and development, to restore its pipeline.
Its major acquisitions include:
- 2015 acquisition of Hospira for $17 billion
- 2016 acquisition of Medivation for $14 billion
These investments have paid off—Pfizer has more than 40 projects in either Phase II or III development.
Source: 2016 Citi Healthcare Conference, page 3
Growth from existing and new products will fuel Pfizer’s earnings. The company expects 6%-8% earnings-per-share growth in 2017.
Pfizer’s steady earnings growth should be more than enough to continue raising the dividend in the high-single digit range moving forward.
Valuation & Dividends
Both Pfizer and Teva are cheap. Pfizer stock has a price-to-earnings ratio of 14.
Teva is even cheaper—based on its adjusted earnings-per-share, the stock has a price-to-earnings ratio of 6.
The reason why Teva is so cheap, could be attributable to headline risk. Investor sentiment has deteriorated as it pertains to the debt-and-acquire pharmaceutical business model.
There have been some high-profile cases of pharmaceutical companies running into trouble after taking on large amounts of debt to make acquisitions.
For example, the crash-and-burn of Valeant Pharmaceuticals (VRX) could be having a ripple-effect on Teva. Investors appear to be shying away from debt-laden serial acquirers.
Teva ended 2016 with $35.8 billion in total debt, up from $9.9 billion at the end of 2015. Cash on hand fell to $1.9 billion at year-end, down from $8.4 billion at same point in 2015.
As a result of the Actavis takeover, Teva has a huge amount of debt on the balance sheet, with little cash left.
Both stocks have above-average yields which look fairly attractive, given that interest rates remain low.
Pfizer has the added advantage of high dividend growth rates. In 2016, the company raised its dividend by 7%.
Meanwhile, Teva hasn’t raised its dividend since 2015, as it has reserved excess cash flow for acquisitions.
Its dividend has not grown much for the past several years.
Source: 4Q 2016 Earnings Presentation, page 35
Another consideration for investors is withholding taxes. Teva is headquartered in Israel. Its dividends are subject to a 15% withholding tax.
So, investors will lose one-quarter of their dividends. Teva’s effective yield is closer to 3.6%.
This is a meaningful difference, and tips the scales in Pfizer’s favor.
Final Thoughts
Teva has gone ‘all-in’ on Actavis. But its balance sheet is now loaded with debt. Judging by its very low valuation, investors do not appear to share Teva’s enthusiasm for huge acquisitions.
If Teva continues to grow sales, earnings, and cash flow, at a high enough rate to pay down its debt, the stock could prove to be a compelling bargain.
Teva has a very low valuation, and a solid dividend yield.
But, ultimately Pfizer has more advantages, without the debt concerns. Pfizer is growing through a more balanced mix of acquisitions and R&D.
Pfizer has a more secure dividend. And, its dividend is not subject to any withholding tax.
Teva stock could have more upside potential, given its extremely low price-to-earnings ratio, but it also carries greater risk.
As a result, Pfizer is the more attractive dividend growth stock.
To see how Pfizer’s dividend stacks up against Dividend Aristocrat Johnson & Johnson, click here.
For a head-to-head matchup of two more high-yield Big Pharma dividend stocks, click here.
