Saturday, January 21, 2012

Merck's Dividend Is NOT At Risk: What Is Austin Smith Smoking? Oh. Right. He's A "Fool!"

In a generally "clue-free" piece for the Motley Fool, one Mr. Austin Smith offers a headline today that blares "The Dow's Scariest Dividend?" -- and makes Merck Exhibit A.

That notion -- to coin a phrase -- is um. . . foolish. His argument, such as it is, is that Merck's earnings levels won't support the dividend payout, because the dividend is about 110 percent of Merck's trailing 12 months' GAAP net income. Of course, to get to GAAP net income, one must deduct even one-time, non-recurring, charges. Charges like transaction-driven (think Schering-Plough bust-up, here) intangibles-and-goodwill write-downs (entirely non-cash), and headcount reduction charges (only partially a cash charge). [The dividend-payment, of course, is a cash item -- so we need be primarily-concerned about Merck's ability to throw off cash here. And that ability seems safe, for now.] Indeed, last year, several one-time largely non-cash charges reduced GAAP net income below the dividend burden by about 10 percent.


What Mr. Smith also neglects to mention is that Merck is significantly under-levered (i.e., carries a lower debt burden), compared to what would be a truly risky dividend company. Merck's debt to equity is only 31 percent; its current ratio (coverage of its current debt) is over 2 to 1. Those are the most-relevant cash-deploying metrics. And these are generally solid, on a fundamental basis (as to dividend safety, at least). It is almost. . . boring. [I actually suspect that these pieces are largely auto-written, by a piece of software that simply churns through industry-groups, and looks for pre-set, brainless trip levels, on GAAP results -- then people like Mr. Smith review, edit and sign their name to them. Every so often, one sees one of these Fool pieces in other sectors -- usually just as clueless.]

In any event, here is a bit of Mr. Smith's poorly-researched take, from this morning:

. . . .The first thing that jumps out at me on this list is Merck. The company has a payout ratio of 111% and it's grown its payout ratio 70% over the past five years despite an 18% retraction in net income over the same period. This doesn't actually mean it grew its dividend, though. The biggest reason is that the company maintained a roughly $0.38 dividend for the past five years despite a decline in net income. Although it has an appealing 4.3% yield, I think it's fair to call it the shakiest dividend on the Dow. Its weak five-year performance isn't encouraging, either. . . .

For dividend investors eyeing the Dow right now, I'd steer clear of Merck. . . .

That's absurd. If you aren't too concerned about near term NYSE price appreciation, Merck will always throw off a solid dividend. That much is a near certainty.

As I say, this is simply a very poor piece of financial analysis pretending to be journalism. And I've made this observation before -- (about a year and a half ago). Merck is a safe, if unexciting dividend play, even in the now nearly unimaginable deflationary scenarios.

Let me say it one other way -- Merck's board would sooner think about an in-place, consensual bankruptcy reorg, before it would think about eliminating the dividend. There are a million other levers the board could pull, before it ever considered a dividend reduction. As a result of Merck's size and scale, the board would have tons of better options to right the ship -- even in a global depression; they'd be (how should I say this? um. . .) foolish to do otherwise.

Here endeth the lesson.


Anonymous said...

Off topic but, I didn't see you capture this:

I missed it too and was made aware of it today based on Pharmalot's news regarding Daxas recent lack of approval in the UK.

Not a big player for Merck but, I also noted that Merck has also taken their CXCR2 antagonist off their clinical pipeline chart (legacy S/P compound).

The only COPD drug left is the inhaled steroid/LABA. Just a retooling of the asthma medicine.

Interesting, I wonder if they're giving up on COPD?

Condor said...

Great pick up!

You are 100 percent right -- I missed it.

Thanks; it is a new post now.