Opinion Profit sharing of R&D-based pharmaceutical companies: Dividends

The Office of Pharmaceutical Industry Research Shinichiro Iida, Senior Research Fellow

Introduction

The pharmaceutical industry is often cited as having higher operating profit margins along with greater investment in R&D expenses than other manufacturing industries. Operating profit is distributed to each stakeholder as financial expenses, tax payments, dividends, and assets. Taxes are highly tax-bearing in comparison to other industries, contributing to domestic public finances. After-tax net income is allocated to dividends to shareholders and assets for future growth. In order to deepen our understanding of the characteristics of the pharmaceutical business, this report focuses on "dividends," the return of profits to shareholders, and analyzes it through comparisons with European and U.S. pharmaceutical companies and other industries in Japan.

Regarding "assets," which are investments for future growth, please refer to the survey and report by Shibukuchi et al. in this issue of the newsletter.

Research Method

Financial data for Japanese, European, and U.S. pharmaceutical companies and the domestic manufacturing industry were obtained from SPEEDA (User Base, Inc.) and the annual securities reports of each company. The fiscal year is the fiscal year of each company, which does not necessarily coincide with the end of the fiscal year. We examined and analyzed the amount of dividends paid and the dividend payout ratio, which provide an indication of a company's dividend policy, as well as the annual dividend per share and dividend yield, which provide an indication of the return to shareholders. We also analyzed the ratio of dividends to shareholders' equity, which measures the level of dividends in relation to shareholders' equity.

The following are the main indicators analyzed.

Dividend payout ratio (%) = annual dividends/net income x 100
Dividend yield (%) = annual dividends/share price (at year-end) x 100
Ratio of dividends to shareholders' equity (%) = annual dividends/shareholders' equity x100

Dividends paid, dividend payout ratio, and ratio of dividends to shareholders' equity were calculated based on the total of the companies surveyed, while annual dividends per share, dividend yield, and share price (at year-end) were calculated based on the average of the companies surveyed.

The following is a list of the companies included in the survey.

Comparison of Pharmaceutical Companies in Japan, the U.S., and Europe

Dividend Payout Ratio

Figure 1 shows the aggregate net income and dividends paid by Japan, the U.S., and Europe, as well as the dividend payout ratio.

Japan: Total net income of Japanese companies increased 1.5-fold from 769.6 billion yen (2010) to 1,139.8 billion yen (2020). Total dividends paid increased 1.7-fold from ¥397.6 billion (2010) to ¥679.2 billion (2019), a compound annual growth rate (CAGR) of 6.1%. The dividend payout ratio required from this was 54% on average over the last five years (2016-2020).
U.S.A.: Net income of U.S. pharmaceutical companies fluctuated from year to year, although there was a steady upward trend; from 2010 to 2019, net income increased 1.7-fold, from $42.3 billion to $74.1 billion. The amount of dividends paid increased 2.0x (CAGR 7.9%) from $21.1 billion to $41.8 billion with no year-to-year decrease. The dividend payout ratio moved from 50% (2010) to 60% (2019), increasing to 49% for the five-year average since 2011 and 78% for the most recent five-year average.
The dividend payout ratio was prominent (97% and 116%) in 2017 and 2020, as total net income decreased significantly, but dividends were returned without reduction. This was indicative of a dividend policy that returns a stable annual dividend to shareholders regardless of net income for each fiscal year.
Europe: A similar trend was observed for European pharmaceutical companies. That is, while net income fluctuated from year to year, the amount of dividends paid grew steadily from $24.5 billion (2010) to $32 billion (2015) The CAGR of the amount of dividends paid in the early 2010s was 7.5%. Net income grew at a low rate, from $41.1 billion to $47.6 billion (1.2x, 2010-2019), and remained almost flat in terms of dividends paid since 2015.
The dividend payout ratio had moved from 60% (2010) to 69% (2019), increasing to 63% for the five-year average since 2011 and 75% for the most recent five-year average.
Dividend Payout Ratio Summary: Table 1 summarizes the total dividend amount paid in FY2020 and the dividend payout ratio for the most recent five years. In terms of the CAGR for the amount of dividends paid, Japan's CAGR was 6.1%, a slower rate of increase than in the U.S. and Europe, and the amount of dividends paid in 2020 was lower in Japan (14 companies) than in the U.S. (8 companies) and Europe (8 companies), at about 1/7 and 1/5 respectively. Dividend payout ratios were above 70% in both Europe and the U.S. Japan's dividend payout ratio was relatively low compared to U.S. and European companies, along with the absolute amount of dividends paid. In addition, US and European companies have increased their dividend payout ratios over the past decade, which is different from the Japanese pharmaceutical companies.

Table 1 Summary of Dividend Payout Ratio

Dividend Yield

We analyzed the single-year returns from a shareholder perspective. Annual dividend per share and dividend ratio per share, i.e., dividend yield, were analyzed (Figure 2).

Japan: The average annual dividend per share for the 14 Japanese pharmaceutical companies was 83 yen (min-max: 28-180 yen, 2020), with no significant increase or decrease since 2009 and a CAGR of 2.1%. Dividend yields averaged 2.8% prior to 2013, but declined to 1.9% on average over the last five years. Since the annual dividend per share remained constant or increased for most of the subject companies, the main reason for the decline in the early to mid-2010s was considered to be the increase in stock prices (more than 1.2x year-on-year in 2011, 2012, and 2014) (see reference figure). Stock splits (two companies in 2014 and 2016), which lowered the price per share, also affected the value of this analysis per share.
U.S.A.: The average annual dividend paid by the eight U.S. pharmaceutical companies was 3.33$ (min-max: 1.52-6.4$, 2020), doubling from 1.52$ in 2010 (CAGR 8.0%). The main reason for the doubling of total dividends paid was found to be dividend increases. The dividend yield was 4.4% in 2010, but declined to 2.6% over the course of 2015. The decline in the early 2010s can be attributed to the increase in stock prices (2010-2015 CAGR 18.4%), which exceeded the increase in annual dividends (reference figure). (2015-2020 CAGR 6.3%) would have been balanced by a slight increase in the dividend yield. In addition, there were glimpses of share buybacks, as the number of shares has declined by about 20% since 2010. Share buybacks may have the potential to return profits to shareholders through higher share prices, increase corporate value, or counter hostile takeover bids, but we did not investigate the details.
Europe: The average annual dividend of the eight European pharmaceutical companies was 3.26$ (min-max: 1.03-9.6$, 2020); it had increased since 2009, when it was 1.96$ and remained around 3$ (CAGR 4.2%). The number of shares had kept the decline to around 5% over the last decade (data omitted).
European dividend yields have fluctuated slightly, but have ranged between 2.7% and 3.6% over the past 10 years, with an average of 3.4% over the last five years.
Dividend Yield Summary: A comparison of annual dividend amounts and dividend yields between Japanese companies and those in Europe and the U.S. (Table 2) shows that annual dividend amounts and dividend yields are both low, at just under one-quarter and less than two-thirds respectively, indicating that the companies return little from their net income to shareholders. The annual dividend growth rate of Japanese pharmaceutical companies was about 1/4 of that of the U.S. and 1/2 of that of Europe, indicating differences among the U.S., Europe, and Japan.
Returns from shareholders' perspective are not only dividends allocated from net income in a single year, but also expectations for capital gains. It should be noted that shareholder returns are not generally small for Japanese pharmaceutical companies. In this analysis, we would like to focus on dividends, which are the shareholder return from a single year's earnings.

Comparison of Domestic Industries

We compared the index of dividends with other domestic manufacturing industries (automobile, electrical, precision, and chemical) (Figure 3).

Figure 3 Comparison with domestic industries

Dividends Paid (per company): Among the industries surveyed, automobiles accounted for the largest portion, at 167.6 billion yen (2019). Pharmaceuticals was less than 30% of automobiles at 48.5 billion yen (2019). No other industry stood out from the rest, and no significant differences were observed.
In terms of the growth rate from 2009 to 2019, the growth rate was 5.1x for automobiles, 4.5x for chemicals and precision, 3.6x for electrical machinery, and 1.8x for pharmaceuticals, which was moderate among the industries surveyed.
Dividend Payout Ratio: In the mid-2010s (2013-2017 annual average), the rate was 57% in pharmaceuticals, 30% in automotive, and 17% in precision, which were high relative to other industries. In the last few years, it increased to 62% (2019) in automotive, comparable to the pharmaceutical industry (60%, 2019). In the Precision industry, where operating margins are higher, the payout ratio was 28% (2019).
The electrical machinery and chemical industries were not analyzed in the total of the surveyed companies, as there were periods in the surveyed period when the dividend payout ratio was not calculated due to negative net income.
Annual Dividend: In the early 2010s, the pharmaceutical industry was high within the industry, showing a payout ratio in the 70-80 yen range, with an average payout ratio of 76 yen for the most recent five-year period; the decrease since 2013 was due to stock splits at two of the companies covered, which increased the total number of shares (from 5.6 billion shares in 2012 to 8 billion shares in 2015), resulting in a relatively lower amount per share C Automobiles saw an increase in annual dividends (CAGR 17%), with the most recent five-year average of 79 yen, higher than the pharmaceutical industry. While the automotive industry experienced a sharp increase from 2013 to 2015 (CAGR 34%, 2010-2015), one possible reason for the decline was a significant decrease in the total number of shares (from 19.8 billion shares in 2012 to 12.6 billion shares in 2014) due to reverse stock splits (two companies). In electronics and chemicals, the reverse stock splits (from 18.3 billion shares in 2017 to 8.3 billion shares in 2018 and from 8.0 billion shares in 2015 to 4.9 billion shares in 2017, respectively) led to a relative increase in annual dividend amounts, reaching around 60 yen in 2019, narrowing the gap between the various manufacturing sectors. The CAGRs of annual dividends were 28% for chemicals, 21% for electronics, and 6% for precision, while pharmaceuticals (2%) was lower than all of them.
Dividend Yield: In the early 2010s, the pharmaceutical industry was high within the industry (about 3%), but this dropped to 2.0% in 2019. It increased in automotive and chemical, at 4.0% and 4.9%, respectively, in 2019. Since dividend yields are affected by changes in stock prices, a comparison of the ratios (annual dividends/stock price) of annual dividend and stock price increases (CAGR, 2010-2019) shows that the ratios were higher in pharmaceuticals (2.1/9.2), automobiles (17.3/4.6), electronics (21.4/17.0), precision (6.4/15.7), chemicals (29. 9/4.9), with dividend yields increasing in Automobiles and Electronics, where the ratio of dividend to stock price growth is high. The same ratio is small for pharmaceuticals, which is thought to have shown a different trend from other industries (see reference chart).
Industry Comparison Summary: In comparison with other manufacturing industries, the dividend payout ratio of the pharmaceuticals industry has remained relatively high, but recently it has been at the same level as that of the automobile industry and has not been outstandingly high. The pharmaceutical industry maintained a high level in terms of annual dividends, but the gap between other industries and pharmaceuticals had narrowed as other industries reduced their total number of shares through reverse stock splits, resulting in larger relative annual dividends.
We analyzed the dividend payout ratio to see the trend of shareholder dividends from net income in a single year. While each company and industry provided a stable annual dividend amount per share, the dividend payout ratio fluctuated significantly because net income changed significantly from period to period. Therefore, we also compared the ratio of dividends to shareholders' equity, which is an asset (ratio of dividends to shareholders' equity) (Figure 4).
The ratio of dividends to shareholders' equity in the pharmaceutical industry has not changed significantly since 2009, averaging 4.3% over 10 years and 4.2% over 5 years. Automobiles and chemicals increased from the 1% range (2009) to 3.7% and 4.5%, respectively, for the most recent five-year averages. Electronics and Precision averaged in the 2% range over the last five years. The trends in the ratio of dividends to shareholders' equity for Pharmaceuticals, Automobiles, and Precision, which can be compared to the dividend payout ratio, were similar to the trends in the amount of dividends paid. This indicator shows little fluctuation from year to year unless the amount of shareholders' equity changes significantly. The average annual net asset growth rate for each industry during the period studied was 1.06 (maximum 1.30, minimum 0.88), allowing for industry comparisons.

Figure 4 Ratio of Dividends to Shareholders' Equity

Summary and Discussion

In this study, we investigated and analyzed the current status of "dividends," the distribution of single-year profits to shareholders, through comparisons with European and U.S. pharmaceutical companies and other manufacturing industries. The following is a summary of the characteristics of Japanese pharmaceutical companies.

Compared to European and U.S. pharmaceutical companies, the dividend payout ratio was 3/4 of 54% and the dividend yield was 2/3 of 1.9%, both small and constant.
Compared to European and U.S. pharmaceutical companies, the amount of dividends paid, the annual dividend per share (83 yen: about 1/4 of the U.S. and Europe) and its annual growth rate (2.1%: about 1/4 of the U.S. and 1/2 of the Europe) were lower.
In comparison to other domestic manufacturing industries, the dividend payout ratio was 60% (2019), similar to the recent domestic auto industry (62%), but difficult to compare with other manufacturing industries on this measure. The annual dividend per share was 76 yen (recent 5-year average), the same level as the recent automotive industry (79 yen), and the dividend yield was 2.0% (2019), about one-half as low as the automotive and chemical industries and on par with the electronics industry.

Compared to Europe and the US, the dividend payout ratio of Japanese pharmaceutical companies was at the same level around 2010, but in recent years it has been lower than in Europe and the US. The reason for this is the difference in the rate of increase in the amount of dividends paid: 7.5% and 7.9% in Europe and the US, respectively, versus a lower rate of 6.1% in Japan. Since the total number of shares of Japanese pharmaceutical companies increased (from 5.7 billion to 7.8 billion) due to stock splits, while the number of shares decreased (from 19.5 billion to 16.8 billion) in the US and slightly decreased (from 15.2 billion to 14.4 billion) in Europe, this difference in dividend payments can be attributed to the increase rate of annual dividends per share. In fact, the same CAGR for Japanese pharmaceutical companies was 2%, about 1/4 to 1/2 that of Europe and the US. The CAGR for annual dividends was also low compared to other industries in Japan. Although caution should be exercised when analyzing the average annual dividend per share because of the effect of stock splits/reverse stock splits, the CAGR of annual dividend amounts paid by Japanese pharmaceutical companies is moderate compared to Europe, the US, and other industries, as evidenced by the total amount of dividends paid. This was also true for the dividend yield results, where the slow rate of increase was considered to be responsible for the low value.

In analyzing the dividend yield, it is necessary to take into account the highs and lows of stock prices, which is the denominator of the calculation formula, as well as the transition of stock prices. The following chart summarizes the trends and growth rates of stock prices. The stock price growth of Japanese pharmaceutical companies (2010-2020 CAGR 7%) was lower than that of the U.S. (12%) and higher than that of Europe (5%). In the most recent 5-year CAGR, Japan's stock price growth was 3%, lower than that of the U.S. (6%) and similar to Europe (3%), indicating that stock price growth is slow. One possible reason why the dividend yields of Japanese pharmaceutical companies declined in the early 2010s and remained flat thereafter was that the stock price growth rate (12%) was significantly higher than the annual dividend growth rate (1%) prior to 2015. In addition, the share price growth rate (3%) remained slightly higher than the dividend yield growth rate (2%) thereafter, which is thought to be the reason why the dividend yield did not increase (Reference Figure CAGR). If Japanese pharmaceutical companies intend to secure dividend yields on par with European and U.S. pharmaceutical companies, or on par with the automobile industry, the rate of increase in dividends will need to be higher than the rate of increase in stock prices.

This study did not examine the background of the pharmaceutical companies, their dividend policies, and the appropriate allocation between dividends and capital gains, so further research and analysis is needed.

In terms of shareholder return from net income for a single fiscal year, Japanese pharmaceutical companies pay a high dividend to net income ratio, but the level is low compared to European and US pharmaceutical companies. In terms of dividend yields, the results showed that they are similar to those of other industries in Japan.

In order for the Japanese pharmaceutical industry to achieve further business growth through the creation of innovative new drugs, it is necessary to raise risk funds from domestic and foreign investors, and we would like to close this report by suggesting the importance of examining the nature of capital market policies.

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