Income investors looking for quality dividend stocks should consider the U.S. health care sector. Due to the necessity of their products and services, many large-cap U.S. health care companies enjoy strong profits and cash flow.
This results in above-average dividend yields across the health care sector. Indeed, many health care stocks have raised their dividends each year for several decades. There are six health care stocks on the list of Dividend Aristocrats, an exclusive group of 57 stocks with at least 25 consecutive years of dividend increases.
The following three stocks represent our favorite health care stocks with the highest expected returns over the next five years, along with the highest retirement suitability.
1. AbbVie Inc. ($ABBV)
Dividend Yield: 5.4%
AbbVie is a global pharmaceutical company that was spun off by Abbott Laboratories (ABT) in 2013. Today, AbbVie generates annual revenue above $32 billion. AbbVie’s most important product is Humira, the top-selling drug in the world.
The challenge for AbbVie is that Humira is now facing biosimilar competition in Europe, which caused international sales of Humira to decline 23% in the 2019 first quarter. U.S. sales of Humira increased 7% last quarter, but Humira will face biosimilar competition in the U.S. in 2023, which remains an ongoing concern.
The good news, is that AbbVie has invested heavily in research and development of new products. For example, Imbruvica grossed sales of $1.02 billion last quarter, up 34% year over year. AbbVie’s hematologic oncology portfolio grew 43% last quarter.
AbbVie forecasts 2020 revenue of more than $16 billion, and 2025 revenue of more than $35 billion, for its product lineup excluding Humira. This will allow the company to continue paying its impressive dividend, currently yielding 5.4%, and grow the dividend each year.
Going back to its days as a subsidiary of Abbott Laboratories, AbbVie has increased its dividend for more than 30 years in a row, making it a Dividend Aristocrat.
In addition, AbbVie stock appears to be significantly undervalued, particularly if the company’s future growth initiatives materialize as planned. Based on expected EPS of $8.78 for 2019, AbbVie stock trades for a P/E multiple of 9.0. We believe AbbVie should trade with a P/E ratio of at least 13, a reasonable valuation multiple for an industry-leading pharmaceutical company. Valuation changes could boost shareholder returns by over 7% per year for the next five years.
Along with the current yield of 5.4% and expected EPS growth of 9% to 10% per year, AbbVie stock could generate total annual returns above 22% per year over the next five years.
2. Cardinal Health ($CAH)
Dividend Yield: 4.3%
Cardinal Health has under-performed the market over the past 12 months, with a decline of 18% compared with a gain of 6% for the S&P 500 Index. This under-performance is due to the threat of e-commerce giant Amazon.com (AMZN) entering the healthcare industry.
Amazon’s $1 billion acquisition of online pharmacy operator PillPack is likely a precursor to a much bigger move into the healthcare industry. This could be a challenge for the established operators, as Amazon has typically under-cut the existing leaders when entering a new industry. On May 9th Cardinal Health released financial results for its fiscal third quarter. For the quarter Cardinal Health reported revenue of $35.2 billion, representing a 4.8% increase compared to the $33.6 billion posted in the same quarter last year. Adjusted EPS totaled $1.59 versus $1.39 in the year ago period, up 14%.
Despite the near-term challenges, Cardinal Health has made strides to return to growth in the near future. Last quarter, Cardinal Health extended its distribution agreements with CVS through 2023. It also acquired mscripts, a company that delivers patient solutions through a mobile app.
Cardinal Health also raised its adjusted earnings-per-share guidance for the year to $5.02 to $5.17 (from $4.97 to $5.17 previously). In addition, the company announced a 1% dividend increase to $0.4811 per quarter, or approximately $1.92 per share annually. Like AbbVie, Cardinal Health is a Dividend Aristocrat with over 30 years of annual raises.
The stock appears significantly undervalued today, with a 2019 P/E ratio of 8.8. A higher multiple could be warranted. For example, a P/E of 12, which would still be below Cardinal Health’s 10-year average valuation, would generate annual returns of 6.4%. Adding in the 4.3% dividend yield along with 5% expected annual EPS growth, results in total expected returns of nearly 16% per year through 2024.
3. CVS Health Corp. ($CVS)
Dividend Yield: 3.7%
CVS Health Corporation is an integrated healthcare services provider that operates a pharmaceutical services business, along with a large chain of pharmacies, including more than 9,700 retail locations and 1,100 medical clinics. CVS has a long runway of growth up ahead, thanks in large part to the $70 billion acquisition of Aetna last year. Acquiring Aetna added one of the largest health benefits providers in the U.S., with more than 44 million members at the time of the acquisition announcement. Recent reports have surfaced that a federal judge may deny the Aetna merger, which would be a negative catalyst for CVS. As this has not officially transpired, and the Department of Justice has recommended the deal be approved, an appeal would be very likely.
Assuming the deal remains intact, the Aetna deal provides CVS with a growth injection, as revenue increased 35% to $61.6 billion in the most recent quarter. The Pharmacy services segment grew revenue 3.1% to $33.6 billion due to brand name drug price inflation and an increase in claims volumes, which were partially offset by pricing pressure and a higher generic dispensing rate. Retail Pharmacy revenue rose 3.3% to $21.1 billion, thanks to 7% prescription volume growth.
Adjusted EPS increased 9.5% from the same quarter last year, to $1.62. CVS increased its adjusted EPS guidance to a range of $6.75-$6.90, up from a prior range of $6.68-$6.88 per share. Still, the revised guidance represents a 3% EPS decline for 2019, due to high integration costs associated with the Aetna takeover. CVS appears undervalued, with a 2019 P/E of 7.9, compared with our fair value estimate of 11.0. Expansion of the P/E multiple could increase shareholder returns by 6.8% per year through 2024.
In response, CVS is working aggressively to cut costs. The company expects $300 to $350 million in cost synergies this year with a total goal of $750 million in 2020. Debt reduction is also a priority, as the Aetna deal saddled CVS with $67.89 billion of long-term debt as of the 2019 first quarter. CVS generated $1.9 billion in free cash flow in the most recent quarter, using $875 million of this to repay debt.
CVS generates strong free cash flow, which gives it the ability to gradually pay down debt and maintain its hefty dividend. CVS has kept its quarterly dividend rate steady since 2016, and may keep the dividend flat over the next couple of years, as the company works toward its debt-reduction goals. But with a 3.7% dividend yield, EPS growth, and a low stock valuation, CVS stock could generate total returns above 15% per year over the next five years.
EDITOR’s NOTE: The day after we received this submission, AbbVie made a $68 Billion bid for Allergan ($AGN), the maker of botox. The proposed merger is already generating controversy. Check back with SickEconomics for more investor friendly analysis as the situation evolves.