Pfizer’s dividend yields twice Merck’s. That gap is a warning, not a gift

By Julia Santos · Founding Editor, DividendsTimes

Educational analysis, not personalized investment advice.

Pfizer (PFE) stock now yields roughly twice what Merck (MRK) pays, and Yahoo Finance flagged that gap this week as a possible warning sign. Fair enough. A lot of retirees own Pfizer for the check and nothing else, so the question of Pfizer dividend safety deserves an actual answer, not a shrug.

I went through the payout ratio, the cash flow statement and the balance sheet, and I used Merck as the control group. Here is where I landed. The dividend is covered today. The cushion, though, is thin enough that the market is pricing in a real chance it stops growing, and a smaller chance it gets reset.

Why the yield is high in the first place

A yield is a dividend divided by a price. That is the whole formula. Pfizer’s dividend has barely moved. The price did the work. The stock has given back most of its pandemic-era gains as Comirnaty and Paxlovid revenue fell from the peak, and investors still refuse to pay up for the pipeline that is supposed to replace that money.

That changes how you should read the number. A yield that climbs because the board raised the payout is a vote of confidence. A yield that climbs because the shares fell is a vote of doubt. Pfizer’s is almost entirely the second kind.

Merck’s yield sits lower for the mirror-image reason. The company has raised its quarterly dividend every year for well over a decade, per its own releases. The stock is hardly loved right now, between Keytruda’s looming patent expiry and weak Gardasil sales in China, but it has not been marked down nearly as hard.

Payout ratio: the first warning light

Set Pfizer’s annual dividend against the adjusted earnings range the company guided to in its most recent outlook and you get a payout somewhere around three-fifths of adjusted profit, by my arithmetic from the company’s own declarations and guidance. On reported GAAP earnings, which carry the restructuring charges from the cost program and the amortization from the Seagen deal, the ratio has run far higher in recent years. At times the dividend has consumed more than the company reported earning.

Merck’s dividend, measured the same way against its recent adjusted earnings guidance, consumes roughly a third. Even after the one-time charge Merck took to buy Verona Pharma, the GAAP payout stayed comfortably below what Pfizer shows on a clean adjusted basis.

Now, a payout at Pfizer’s level is not dangerous on its own. Plenty of consumer staples live there for decades. The problem is what sits behind the earnings number. Pfizer has said that products including Eliquis, Ibrance, Xtandi and Prevnar lose exclusivity over the next few years, and management has previously sized the revenue at risk from patent expirations through the end of the decade in the high teens of billions of dollars. Earnings that are about to shrink turn a comfortable payout into a tight one on a forward basis, unless the new drugs fill the hole on schedule. New drugs rarely fill holes on schedule.

Free cash flow coverage: tighter than the payout ratio suggests

Earnings can be adjusted. Cash is harder to argue with. Pfizer’s latest annual report showed operating cash flow, less capital spending, covering the dividends paid with only a few hundred million dollars to spare. Call it coverage of about one times. One bad working capital swing, one legal settlement, and that line goes negative.

Merck’s latest annual filing reads like a different industry. Free cash flow covered the dividend more than twice over, with room left for buybacks and deals without touching the payout.

Pfizer’s answer has been to cut costs. The company has said it would deliver several billion dollars of net cost savings by the end of this year, with a further tranche targeted after that, plus a reorganization of research spending, per its releases. If those savings land and revenue holds inside guidance, coverage improves meaningfully. If revenue slides to the bottom of the range, the savings mostly cancel out the erosion and coverage stays parked near one times. That is the scenario I would plan around.

Debt: where Pfizer dividend safety gets tested

Pfizer borrowed heavily to buy Seagen and has been paying that down, but its latest annual filing still showed total debt far above where it stood before the deal. Then, late last year, it agreed to acquire Metsera, the obesity drug developer, in a deal the company valued at up to roughly ten billion dollars including contingent payments. Management says deleveraging and the dividend come before buybacks. That is the right order. It also means there is no third lever to pull. Every dollar of free cash flow left after the dividend is already spoken for.

Merck also spent roughly ten billion dollars on Verona Pharma, per its release, and its debt rose accordingly. The difference is that Merck’s cash generation absorbs a purchase that size in well under a year. Pfizer’s does not.

Credit ratings tell the same story in shorthand. Both companies remain investment grade, but Pfizer’s agency ratings have drifted lower since Seagen while Merck’s have held. A downgrade would not cut the dividend by itself. It would raise the cost of rolling over the debt that the dividend competes with for cash, which is the slow version of the same problem.

What it means for retirees living on dividends

If you own Pfizer for income, here is the honest position. The quarterly payment is covered by cash flow today, and management has said repeatedly that maintaining it is a priority. A cut in the next twelve months would take a surprise: a failed launch, a large litigation charge or a revenue miss well below guidance.

What you should not count on is growth. Pfizer’s annual increase has been a penny a share for several years. With coverage near one times and a patent cliff starting now, a frozen dividend is a plausible base case. Maybe the base case. On a yield this high, a freeze is tolerable.

A reset to whatever level the post-cliff business can support would be another matter entirely. Pfizer has done it before. It halved the payout to fund the Wyeth deal during the financial crisis. That precedent is the reason the market refuses to give Pfizer the benefit of the doubt, and I think the market is right not to.

Merck pays you less and asks you to trust that the pipeline, meaning Winrevair, the Verona drug Ohtuvayre and the subcutaneous Keytruda, can bridge the cliff later this decade. Its payout ratio and its coverage leave room to keep raising the dividend through that transition even if earnings dip for a year or two.

Three things are worth checking in your own holdings. Start with concentration. If Pfizer is more than a few percent of your income, a freeze or cut shows up in your budget, not just your statement.

Then look inside your dividend ETFs. Many high-yield screens, particularly the ones that weight by yield, carry Pfizer at a large weight precisely because the yield is high, so you may own more of it than you think.

Last, ask whether you are being paid enough for the gap. Pfizer’s yield premium over Merck is wide, and that premium is the market’s estimate of the risk. Nobody is handing that out for free.

What to watch

Pfizer reports third-quarter results in early November. Two numbers matter: year-to-date operating cash flow, and whether the company reaffirms next year’s revenue range. Pfizer usually declares its first-quarter dividend in mid-December, and that announcement will tell you whether the penny-a-year streak continues, goes flat or breaks.

For Merck, the dividend declaration typically lands in late November, and a raise of a few cents would confirm the pattern. The first patent challenges to Keytruda, plus the pace of Ohtuvayre and Winrevair sales in the quarterly reports, are the leading indicators of whether Merck’s cushion holds through the cliff.

On Pfizer’s balance sheet, watch year-end total debt against the company’s own deleveraging commentary. A reported figure heading back toward the Seagen peak after Metsera closes would be a reason to reassess everything above.

Frequently asked questions

Is Pfizer’s dividend likely to be cut next year?

Not on current numbers. Free cash flow covers the payout, and management has said the dividend ranks ahead of buybacks. The nearer risk is a freeze. A reset becomes more likely later in the decade if the patent losses are not offset.

Why is Merck’s dividend considered safer when it also faces a patent cliff?

Merck’s dividend consumes roughly a third of adjusted earnings and well under half of free cash flow, per its latest annual filing. Pfizer’s consumes around three-fifths of adjusted earnings and nearly all of its free cash flow. Merck can absorb a bad year without touching the payout. Pfizer cannot absorb much of anything.

Should an income investor swap Pfizer for Merck?

Depends what you need the money for. Pfizer’s yield is roughly double Merck’s, so a straight swap cuts your current income about in half in exchange for a growing, better-covered payment. Holding both, with Pfizer sized small enough that a freeze does not matter, is a reasonable middle path and the one I would take.

Educational analysis, not personalized investment advice.