Pharmaceutical company Pfizer Inc. (NYSE:PFE) has been doing some interesting things lately. The company has been shedding its non-pharmaceutical assets in order to focus on its core business which carries high profit margins. In April 2012, Pfizer sold its infant nutrition business to Nestle, and this February, the company spun off its animal health business Zoetis.
Pfizer Inc. (NYSE:PFE)’s stock has fallen more than 10% from its high in April, pushing the dividend yield up to 3.45%. This increased yield, along with faster dividend growth than peers, makes Pfizer one of the best big-pharma dividend stocks out there.
A troubled past
Big pharmaceutical companies typically grow their dividends slowly, and Pfizer Inc. (NYSE:PFE) is no exception. From 2003 to 2012, Pfizer’s dividend grew at an annualized rate of just 4.3%, and in 2009, the company was forced to cut its dividend dramatically. The good news is that Pfizer has a far lower payout ratio with respect to the free cash flow than competitors like Merck & Co., Inc. (NYSE:MRK) and Eli Lilly & Co. (NYSE:LLY).
| Company | Payout ratio |
|---|---|
| Pfizer | 42% |
| Merck | 64% |
| Eli Lilly | 51% |
This allows Pfizer some room to grow the dividend, and at the end of last year, the company raised the dividend by 9%. But the big story here is the massive share repurchases which Pfizer Inc. (NYSE:PFE) has been doing.
Being aggressive
Pfizer has been using the cash generated from selling off its non-core assets to aggressively repurchase its shares. From 2011 through the first quarter of 2013, the company spent a total of $21.8 billion on share repurchases, reducing the share count by just about 10%. What’s more, the company still owns 80% of Zoetis, a position which it plans to unwind in short order. That’s nearly an additional $10 billion which can be used for share buybacks.
On top of that, the company generated over $15 billion in free cash flow in 2012, and after the dividend payment, that leaves about $9 billion which could be used for buybacks. Reducing the share count lowers the total dividend payment that the company has to make, thus lowering the payout ratio and creating more room for future dividend growth. And given that the stock trades at less than 13 times the free cash flow, the company is paying a reasonable price for its own shares.
Because the cash flow is so robust, Pfizer Inc. (NYSE:PFE) hasn’t needed to increase its debt in order to fund the buybacks. The company has a total of $40 billion in debt and an additional $11 billion in pension obligations, but cash and investments cover nearly all of that at $50.7 billion. Some companies take on huge amounts of debt to fund buybacks, which in general I don’t like, but Pfizer doesn’t have to.
