The Swiss pharmaceutical Roche (ROG.SW) has a very impressive track record. The company has a long history of steady dividend increases. In fact, Roche would qualify as a true European Dividend Aristocrat, if its dividend payout were measured in its home currency (CHF). Roche is one of the few European dividend stocks with at least 25+ years of consecutive dividend increases each year.
This article will discuss Roche’s business model and why the stock could be attractive for income investors based on our Smart Dividend Score. Our Dividend Score System takes into account several fundamental and technical metrics that affect a company’s ability to continue paying dividends and its overall return.
Business model and growth perspective
Hoffmann-La Roche AG, founded in 1896, is a Swiss multinational healthcare company that operates worldwide under two divisions:
- Pharmaceuticals (80%)
- Diagnostics (20%)
Its holding company, Roche Holding AG, has bearer shares listed on the SIX Swiss Exchange. The company headquarters are located in Basel. Roche is the second-largest pharmaceutical company worldwide and has a market capitalization of nearly $260 billion (11/18/2019).
Sales in the first nine months of 2019 totaled 46.07 billion Swiss francs ($46.16 billion), up from CHF42.08 billion a year earlier. U.S. sales were particularly strong, rising 17% to CHF20.04 billion.
Its pharmaceutical business is mainly based on oncology and immunology. Roche’s strong brands and more important in this business its pipeline have helped to generate revenue growth consistently each quarter, over the past 8 years. Roche’s forecasted earnings growth is 6.9% per year by analysts. Roche expects sales to grow in the high-single digit range (6%-9%), at constant exchange rates, for FY-2019, as reported in the Q3-2019 trading update.
Geographically, Roche is also well positioned, with a good sales split between the U.S., Europe, and the emerging markets.
In order to generate sustainable growth over the long-term, competitive advantages are critically important. Sufficient spending on R&D is critical for health care companies. Roche kept its R&D investments stable over the last 5 years around 19% of the total sales costs. This R&D investment is clearly visible in the product pipeline.
To summarize, Roche is a typical wide-moat company, with strong patents, and a strong brand active in a growth market.
Dividend history and dividend growth
It is important that companies that can maintain or even increase their dividend payments in bad times. This is an indication that the company has a strong market position in a stable business that performs well throughout the economic cycle.
Roche is a true European dividend aristocrat with 32 years of consecutive dividend increases. So, also during recession periods, Roche has been able to increase dividends.
The 10 years dividend growth rate is 6.1%. The last dividend increased was from 8.30 to 8.70 CHF over the fiscal year 2018, paid in 2019. Unlike many US dividend stocks, Roche dividend is paid once per year in March. Foreign investors should take the potential impact of the swiss dividend withholding tax in mind.
With Roche trading around 302 CHF and 8.70 CHF, the current dividend yield is 2.94%. The 5-year average dividend yield is 3.20% (see red-line in the chart). This indicates the stock looks reasonably valued today. This dividend yield is higher than the bottom 25% of dividend payers in the Swiss market (1.84%) and near the industry average of 3.0%.
The dividend payments are reasonably covered by its earnings, given the payout ratio of 63%. Looking forward, Roche’s dividends in 3 years are forecast to be well covered by earnings (46.4% payout ratio). In short, investors do not have to worry about the sustainability of the dividend.
Stable cash flow
Without stable cash flow, it is almost impossible to maintain the dividend in times of a downturn. Operating free cash flow and free cash flow are 2 important metrics for a dividend stock. As you can see in the diagram below Roche is clearly able to create a continues and growing (Operating) free cash flow. Looking at the current product pipeline, one can expect this pattern will continue.
Low debt ratio
Companies with a low debt ratio have the option of maintaining or even increasing the dividend even during recessions. The (net) debt-to-EBITDA ratio is a great metric to include. The net debt/EBITDA of 0.2 is indicating that Roche’s position is rock solid. This is also well below the 1.5 net debt/EBITDA ratio we prefer for dividend stocks.
At this moment Roche is at a normal value based on its PE Ratio (21.4x) compared to the Pharmaceuticals industry average (21.4x). The historical 10-year average PE ratio is also close with 20.1%. The forecasted EV/EBITDA is 10.5
This valuation is comparable with competitors like Johnson & Johnson, Novartis, and Sanofi.
It is important to analyze the performance of a dividend stock during a recession period. We analyze each dividend stock by looking at their earnings, dividends, maximum draw down (MDD) and stock price performance during the 2007-2009 financial crisis.
Roche had some difficulties during the recession 2007-2009, but manage to increase its dividends and the price-performance was still okay. The table below lists the share-price performance per year, the performance over 2007-2009 and the MDD.
|2007||2008||2009||Period: 2007-2009||Maximum Draw Down (MDD)|
|Roche Holding AG||-12.48%||-16.92%||8.18%||-21.34%||-48.31%|
Year-to-date Roche is trading up 18.8%, which is an above-average performance for this stock. The 10-year geometric annual performance is 6.5% annually. Looking at the win-ratio of 65% and a loss ratio of 2.19, the performance is just below average for this stock.
Roche performance triangle.
Over the last 10 years, Roche’s total return is 163.2%, resulting from an 85% share price increase and dividends contributed 78.2%. The annualized total return for this period is 10.16%.
The health care sector is a great place to look for high-quality dividend stocks. Roche is one of the few true European dividend aristocrats. Given the current valuation and dividend yield Roche is an interesting stock for conservative investors. Roche will be able to continue the dividend growth and continue to grow sales in the high-single digit range (6%-9%). This is important since the dividend payout is an essential component of the total return. In short, investors do not have to worry about the sustainability of the dividend.