Blue chip stocks are attractive for a number of reasons.
Typically, these are quality businesses that have shown the ability to generate long-term growth. In turn, they have established track records of rewarding shareholders with steady dividends, even during recessions. And, they have the potential to raise their dividends over time.
Blue chip stocks can come from virtually any market sector. Here we will discuss a diversified group of high-yielding blue chips that also happen to be undervalued.
Undervalued Blue Chip Stock: Bank OZK
Bank OZK (OZK) is a diversified financial institution that offers various retail and commercial banking services. The company has a variety of deposit-taking products for consumers and institutions, and makes loans against real estate, businesses, agriculture, homebuilding, and more. Bank OZK also offers trust and wealth services, including retirement accounts, investment management, corporate trusts, and more. The company operates 240 offices in eight states.
In the 2022 second quarter, the company posted a double-beat. Revenue increased 9% to $292 million, which was $5 million above estimates. Meanwhile, earnings per share of $1.10 beat by $0.08 per share. Net interest income was $266 million, up from $249 million in Q1 and $241 million a year ago. Net interest margin was 4.52%, up sharply from 4.25% in Q1 and 3.95% in the year-earlier period. Total loans were $18.7 billion at the end of the quarter, down ~$200 million from Q1. Deposits were down as well, declining from $20.3 billion to $20.0 billion from Q1 to Q2.
Bank OZK is a shareholder-friendly company. The bank routinely increases its dividend more than once per year. The company has increased its dividend for 27 consecutive years, making it a Dividend Champion. It has grown its dividend at an average annual rate of 18% over the past 10 years. The shares currently yield 3%. With an expected dividend payout ratio below 30% for 2022, the dividend is highly secure with room for continued increases.
The bank also repurchases shares to boost its EPS growth. Bank OZK bought back 3.7 million shares of stock for $147 million during Q2.
Shares of Bank OZK currently trade below 10 times forward earnings, which is not only very low by historical standards, but is well below our estimate of fair value. We view fair value for OZK stock at 11 times EPS. This means if the P/E ratio were to expand to 11 over the next five years, it would generate a ~4% annual tailwind to total returns.
In addition, we expect at least 3% annual EPS growth for OZK. Combining the 3% dividend yield, total returns could reach 10% per year over the next five years.
Undervalued Blue Chip Stock: Merck
Merck & Company (MRK) is one of the largest healthcare companies in the world. Merck manufactures prescription medicines, vaccines, biologic therapies, and animal health products. Merck generates annual revenues of ~$58 billion.
On July 28, 2022, Merck reported second-quarter results for the period ending June 30, 2022. Revenue improved 28.1% to $14.6 billion, easily topping estimates by $750 million. Adjusted net income of $4.7 billion, or $1.87 per share, compared very favorably to adjusted net income of $1.6 billion, or $0.61 per share, in the prior year and was $0.16 above expectations.
Pharmaceutical revenue increased 28% to $14.6 billion for the quarter, with Lagevrio sales adding $1.2 billion, down from $3.2 billion in the fourth quarter of 2021. Keytruda, which treats cancers such as melanoma that cannot be removed by surgery and non-small cell lung cancer, remains the key driver of growth for the company, with sales higher by 26% to $5.3 billion for the quarter. The product eclipsed the $17 billion mark for revenue in 2021, a 20% improvement from the previous year, and could reach $20 billion this year. Keytruda continues to see gains in market share across a number of indications. Sales for Merck’s HPV vaccine Gardasil grew 36% to $1.67 billion due to particularly strong demand in China.
Merck provided an updated outlook for 2022 as well. The company narrowed adjusted EPS guidance to a range of $7.25 to $7.35, compared to $7.24 to $7.36 per share previously. Revenue is projected in a range of $57.5 billion to $58.5 billion, up from $56.9 billion to $58.1 billion and $56.1 billion to $57.6 billion previously.
Merck & Company is expected to offer a total annual return of 12% over the next five years. This projected return stems from annual expected EPS growth of 5%, a dividend yield of 3.1%, and a mid-single-digit contribution from multiple expansion.
Undervalued Blue Chip Stock: Sonoco Products
Sonoco Products (SON) provides packaging, industrial products and supply chain services to its customers. The markets that use the company’s products include those in the appliances, electronics, beverage, construction and food industries. The company generates about $7.2 billion in annual sales. Sonoco Products is now composed of two segments, Consumer Packaging and Industrial Packaging, with all other businesses listed as “all other.”
On July 21, 2022, Sonoco Products reported second-quarter earnings results. Revenue surged 38.4% to a company record $1.91 billion, which was in line with analysts’ expectations. Adjusted EPS of $1.76 compared very favorably to $0.84 in the prior year and was $0.11 above estimates. Consumer Packaging revenues grew 65.6% to a segment record $990.1 million, due once again in large part to the purchase of Ball Metalpack that closed in the fourth quarter of 2021.
Higher selling prices also factored into results. Global rigid paper containers had slight volume growth outside of North America, where supply constraints limited business. Flexible packaging volume grew 4%, but was offset by mix. Industrial Paper Packing sales grew 20% to a segment record $727.4 million as higher selling prices more than offset a small volume decline and currency exchange headwinds.
Sonoco Products raised its outlook for 2022 as well, with the company expecting adjusted EPS of $6.20 to $6.30 for the year, up from $5.25 to $5.45 and $4.60 to $4.80 previously.
On April 20, 2022, Sonoco Products raised its dividend by 9% to a quarterly rate of $0.49. This extends the company’s dividend growth streak to 40 years. The shares currently yield 3%.