Game Plan: Merck Is Right for This Market

Here’s your Game Plan for weeks to come: Seek out stocks with good dividends. Buy only those with companies that have a history of at least maintaining those payouts, if not increasing them. And make sure the companies you consider can withstand a recession.

Merck , Cramer said, is a near-perfect choice. Historically, drug companies’ earnings hold up well during a recession, and the recent sell-offs have driven the stock down but the dividend up, to 5.1%. That’s better than Treasurys, and dividend income is taxed at a lower rate. Plus, the company’s been through tough times before – when Vioxx was taken off the market in 2004 and three ratings agencies simultaneously downgraded Merck’s debt – and actually raised the dividend. So that yield should be safe.

There are drug companies with higher dividends. Eli Lilly and Pfizer yield 5.75 and 7.5%, respectively. But Cramer said that Merck’s net cash of $5.6 billion is double that of Pfizer and triple that of Lilly. And while Lilly may be ahead of Merck in terms of expected earnings growth, Merck’s core value – cash on hand plus the value of the company’s existing drugs minus an industry discount – makes it a much more valuable stock. Merck is trading at just about its core value of $29.90. Pfizer and Lilly trade a couple of points higher than their own. So right now Merck is the cheaper company.

Merck has had its share of problems during 2008 as well. Drugs from Vytorin and Zetia (cholesterol) to Gardisil (HPV) to Singulair (asthma) have run into problems, and drug sales guidance has been reduced by 5% for the second half of this year. Cramer knows this. But no one seems to take into account the expected $4.5 billion and $ 5 billion in savings by 2010 put in motion by CEO Dick Clark. MRK stock is exactly where it was before Clark announced his five-year plan even though the company is half way there. And cash flows are expected to increase 11% to 15% from 2007 levels. Cramer thinks more and more investors will buy Merck as a haven from the coming recession.

So how do you play it? Merck reports earnings Wednesday, Oct. 22, so Cramer recommended buying half a position before then. The stock is up Friday after a UBS upgrade, so wait to buy another quarter of a position until MRK drops to $27.60, when the dividend’s up to 5.5%. Buy the next quarter position when the yield gets to 6%, which is at $25.33. Worst-case scenario Merck goes up, and you make money that way, too.

Merck beat the Street’s estimates the last two quarters and the stock still sold off. So investors might get a great buying opportunity after Wednesday. In fact, for Merck to go up, Cramer thinks the company would have to reinstate its full-year guidance, announce a big buyback program, raise its dividend or announce that certain products’ sales were stronger than expected.

Regardless, though, Cramer figures Wall Street will consider this Merck’s last bad quarter, if the company disappoints, so the stock should rebound if a post-quarter sell-off happens.

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