The Standard & Poor's 500 is currently trading at a forward price-earnings (P/E) ratio of 17.1. The valuation of the stock market is well above the five-year average (15.1) and its 10-year average (14.4) as well. That is making it difficult for dividend investors to find new potential candidates for purchase, especially after the election rally.
Many stocks within the financial and industrial sectors that were appealingly priced last October are now up double digits in price, offering a less attractive entry point. However the health care sector, which was down 3% last year, offers opportunity for dividend investors.
There is something appealing about owning a high-yield health care investment that can produce solid income each year. Part of the attractiveness of any dividend stock candidate is also if the firm’s stock has struggled and thus trades at a low historic valuation. There are few stocks trading at low historic valuations and high dividends today that have also suffered price declines of more than 5% in the past 12 months. Cardinal Health and Novartis are two such firms that fit the bill.
Firm 12-month %
Cardinal Health is one of the primary distributors of pharmaceuticals and medical supplies to pharmacies and hospitals. Cardinal Health is also a dividend aristocrat, a premiere list of firms within the S&P 500 that have increased their dividends for 25 consecutive years. As the S&P 500 stock index climbed by double digits over the preceding 12 months, Cardinal Health’s stock has dropped by 8.2%. Consistent rhetoric on drug prices and especially wholesale firms like Cardinal have put pressure on the shares.
Cardinal Health is a large and profitable health care firm. The firm generates more than $120 billion in total revenue. On May 4, 2016, Cardinal Health announced that its board of directors approved a 16% increase in the company’s quarterly dividend to 44.89 cents per share, or $1.73 per share on an annualized fiscal year basis.
| Total dividends in 2016 | $1.73 |
| Total dividends in 2015 | $1.50 |
| Total dividends in 2014 | $1.33 |
| Total dividends in 2013 | $1.18 |
| Total dividends in 2012 | 96 cents |
The firm is on an acquisition tear to better diversify revenue and increase growth prospects. Cardinal Health acquired Cordis and the Harvard Drug Group in 2015. The acquisition of the Harvard Drug Group gives Cardinal additional exposure to generic pharmaceuticals and over-the-counter medications. Cardinal Health expects accretion in EPS of more than 20 cents from the Harvard Drug Group acquisition for fiscal 2017.
The acquisition of Johnson & Johnson’s (JNJ, Financial) Cordis business adds cardiology and endovascular devices to Cardinal’s inventory and will enhance the firm’s portfolio of cardiovascular, wound management and orthopedics products. The company also expects fiscal 2017 accretion of greater than 20 cents per share. Management expects continued synergies will exceed $100 million annually in fiscal 2018 and beyond. These acquisitions along with internal growth allowed Cardinal Health to report first-quarter fiscal year 2017 revenue of $32 billion, an increase of 14% from the comparable quarter last year.
These acquistions will help offset recently lost supplier contracts with Express Scripts (ESRX, Financial) Mail Order Pharmacy and Walgreens (WBA, Financial). But margins on these contracts are razor thin at just above 1%. Demographic trends are in the firm’s favor as older Americans will continue to utilize pharmaceuticals as the baby boomers continue to age.
The firm also disclosed that its board of directors approved a new authorization to repurchase up to $1 billion of Cardinal Health common shares. The new share repurchase program is in addition to the program approved in August 2014, of which $393 million remains available. Stock analysts project fiscal year 2017 earnings at $5.45 and 2018 earnings at $6.05.
Priced at $73.50, the company’s forward P/E ratio is 13.48. This is well below the forward market multiple of 17.1. Its yield of 2.35% is just above the market. Cardinal Health’s ambitious acquisition strategy and concentration on specialty drugs should allow the health care firm to meet or potentially exceed analyst projections in the latter half of 2017. Double-digit dividend growth by Cardinal Health is also most likely as its low 43% payout ratio allows for a continued ramping of its dividend for patient investors.
Novartis is a large pharmaceutical firm based in Switzerland. Its shares trade on the New York Stock Exchange as an American Depository Receipt, or ADR. The company was created by the merger of Sandoz AG and Ciba-Geigy AG in December 1996. It is primarily a pharmaceutical company but also a major producer of generic drugs through its Sandoz division. It offers eye care products through its Alcon division and also sells consumer and animal health products. Pharmaceutical products account for 55% of sales, generics for 16% and eye care for 19%.
Novartis’ stock has fallen by over 7% in the past 12 months. This is due to the firm losing cardiovascular drug Diovan and cancer drug Gleevec to patent losses. Its Alcon division is also facing challenages. Novartis has several key new drugs that will offset these losses including Cosentyx. Cosentyx generated $301 million in the third quarter, above the $260 million in the second quarter. Cosentyx could generate peak sales of nearly $5 billion.
Entresto remains a key focus for Novartis as the firm has spent considerable efforts to expand sales of the cardio drug. The firm is rolling out a new clinical program called FortiHFy for preventing heart failure. Most estimates for the drug are above $3 billion by 2021. The firm also has Gilenya, an oral drug for multiple sclerosis. It generated $790 million in sales for the third quarter, up 15%. Other key pipeline drugs include LEE01 (CDK4/6 in HR+ HER2 advanced breast cancer), PI3K cancer drugs (alpelisib, buparlisib and afuresertib) and AMG334 for migraines. All are potential blockbuster drugs with peak sales potential of over $1 billion.
As for dividends, Novartis offered investors a 4% increase in the dividend payment to 2.70 Swiss francs ($2.65) per Novartis share for fiscal 2015 on Feb. 23, 2016. This represents the 19th consecutive increase in the dividend paid per share since the creation of Novartis in December 1996. U.S. investors' actual dividends will be impacted by the currency fluctuation in the U.S. dollar vs. the Swiss franc.
| Total dividends in 2015 | 2.70 |
| Total dividends in 2014 | 2.60 |
| Total dividends in 2013 | 2.45 |
| Total dividends in 2012 | 2.30 |
| Total dividends in 2011 | 2.25 |
Analysts expect Novartis to post earnings of $4.95 a share for each ADR next year. Priced at $72 a share, Novartis trades at a very reasonable 14.5 times earnings. It currently offers investors a generous 3.75% dividend yield with the potential for another single-digit increase at the board meeting in February. As Novartis maintains multiple different operations in pharmaceuticals, generic drugs and eye care – the firm offers balance for any dividend investor. Along with Cardinal Health, it is a great selection for any investor seeking out-of-favor dividend stocks.
Disclosure: I am long Cardinal Health and Novartis.
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