Could Merck Become Pharma's Yield King?

Merck could increase the size of the dividend payment it makes to shareholders every quarter following its $41.1 billion purchase of rival Schering-Plough , although the company will not commit to an increase now.

Chief Financial Officer Peter Kellogg told analysts and investors Thursday that Merck "will be generating a lot of cash" and that the company does see the need to "ultimately make sure shareholders benefit from that." He also said, "It's too early to declare how we will do that."

Kellogg made his comments at the Strategic Decisions conference, organized by Sanford C. Bernstein, in response to a question from Timothy Anderson, Bernstein's pharmaceuticals analyst. Anderson noted that Merck had previously stated it intends to have free cash flow of $15 billion by 2013, potentially making a bigger payout possible. (Click here for a transcript of Merck's presentation at Strategic Decisions.)

In a note to investors Friday, Anderson noted that Merck shares already have a dividend yield around 6%. Right now, Merck has committed only to maintaining its current dividend after the merger, but any increase could make the new company "the highest-yielding drug stock," Anderson says, "and this would probably be received well." He writes that his calculations show no increase is likely until next year.

Investors are already looking for a dividend increase from Merck's longtime rival Pfizer , which is spending $68 billion to acquire Wyeth . Pfizer cut its dividend to help pay for the deal, but in a May 12 note to investors, Catherine Arnold, the pharmaceuticals analyst at Credit Suisse , wrote that would be "surprising" if Pfizer didn't boost its dividend after it integrates Wyeth.

Both Merck and Pfizer are facing patent expirations on top-selling drugs, but their respective mergers will allow for dramatic cost cuts. Year-to-date, Merck shares have dropped 10% and Pfizer shares are down 15%.

Aside from patent expirations, Merck is facing disappointing sales of its Gardasil vaccine for the virus that causes cervical cancer and eroding sales of the cholesterol drugs Vytorin and Zetia, which it sells with Schering.

Johnson & Johnson is also challenging whether Schering should retain the rights to sell J&J's rheumatoid arthritis drugs in international markets. Analysts say that Merck appears to have the upper hand in the battle, but some expect the company to make some concession to J&J in order to get the Schering acquisition done.