I was a fan of Pfizer (PFE) early in 2012, and the stock delivered good returns as it beat the S&P 500. At this new, higher, price level it is a little harder to have quite the same affection for the company. I do have respect for how the company has streamlined - cutting costs, selling the nutrition business to Nestle, and preparing for the spin-off of Zoetis. I also think there are some worthwhile drugs both in the pipeline and early launch phases. All that said, it's hard to be as excited about the stock's value today, and I wonder if it's time for another large-scale move to better position the company for long-term growth.
Fourth Quarter Results Offer Some Upside
Pfizer is enormous and closely-followed, but that didn't preclude a few surprises in this quarterly report.
Revenue fell 7% as reported and 5% on a constant current basis, good for about a 5% upside surprise relative to sell-side estimates. Human health (pharmaceuticals and vaccines) revenue fell 9%, but still surprised positively, and consumer sales were likewise better than expected at 22% growth. There weren't many huge surprises by revenue line-item (more like an extra $10 million here and there), but Prevnar 13 vaccine sales were notably strong (up 19%), and Celebrex (up 12%) and Lyrica (up 13%) also stood out.
Pfizer's profitability was a little more mixed, but still positive on balance. Adjusted gross margin declined by a point and a half and missed most analyst targets, but SG&A spending also came in lower than expected. While operating income did fall 4%, it was still solidly better than most estimates.
New Drivers Lining Up
Pfizer has a relatively weak pipeline within the Big Pharma space, but the company has significant drugs very early in their commercial lives. Eliquis, which the company sells in partnership with Bristol-Myers Squibb (BMY), is on the market for stroke prevention in atrial fibrillation patients and not only holds multi-billion dollar potential, but strong data relative to Xarelto (marketed by Johnson & Johnson (JNJ) and Bayer) and Boehringer's Pradaxa. Investors should keep a lookout for upcoming data from Daiichi Sankyo's edoxaban (a potential competitor), but Eliquis looks to be in good shape.
Xeljanz (aka tofacitinib) is also now ready for prime time, and with a pretty favorable label on balance. I suspect that doctors are going to take things carefully at first, particularly for patients well-controlled by TNF inhibitors like AbbVie's (ABBV) Humira, but this too should be a multi-billion dollar drug for Pfizer over time. Moreover, with the difficulties at Rigel (RIGL)/AstraZeneca (AZN) with fostamatinib, Pfizer may have less to worry about in terms of competition (though I wouldn't ignore the Lilly (LLY)/Incyte (INCY) partnership with baricitinib).
After these two star attractions, there is also the potential to consider from drugs like Xalkori (initially approved in non-small cell lung cancer, but being tested in additional applications) and the Prevnar 13 vaccine.
Pfizer has also presented Phase 2 data from CFK 4/6 inhibitor PD-991 (licensed from Onyx Pharmaceuticals (ONXX)) that suggests it is worth following as a potential player in HER2-/ER+ breast cancer. This is a sizable addressable market for Pfizer (more than 50,000 patients per year), and the median progression-free survival of 26.1 months versus the control of 7.5 months (along with a hazard ratio of 0.37 and overall response rate of 45% versus 31% in the control group) suggests that Pfizer may have something interesting here. Should these data hold up, the potential could easily fall in the $1 billion to $2 billion range, and perhaps up to $3 billion or more.
And Then What?
The problem for Pfizer is that while these new drugs are promising, all together they don't add up to a new Lipitor - the company's ultra-blockbuster cholesterol drug that has since gone generic. And while it's all well and good for Pfizer management to eschew chasing the next ultra-blockbuster in favor of a more balanced approach, the reality is that the company is still staring at many years to come of fairly marginal revenue growth.
True, the company is doing well in emerging markets (up 20% in constant currency this quarter, to almost 18% of total revenue), and Pfizer has relatively low patent risk over the next three to five years, but that still leaves the cupboard looking a little bare. Moreover, I have to wonder if Pfizer can continue to drive such solid margins and high free cash flow conversion with the de-leverage that comes from lower or flat sales.
That leads me to wonder if management isn't contemplating something bigger. Pfizer's CEO openly said, "we will continue to foster our two distinct operating models," leaving me wondering if some sort of additional split or restructuring could develop.
I also believe Pfizer could, and should, at least contemplate a large acquisition. A buy-and-cut deal for another Big Pharma could make some sense, though I think the extreme cost-focus of Big Pharma in recent years does take away some of the allure of "growth by firing." Personally, I'd favor a move for a company like Biogen Idec (BIIB), Celgene (CELG), or Gilead (GILD) - a move that would give the company a very strong position in markets with large opportunities (multiple sclerosis, oncology, and virology, respectively). A deal for a specialist in orphan drugs (like Alexion (ALXN) or BioMarin (BMRN)) could likewise fit the bill, though I'm not in favor of the steep premium Pfizer would have to pay.
The Bottom Line
Given how big Pfizer is and how difficult it is to develop a needle-moving blockbuster for a company with almost $60 billion in annual revenue, I think Pfizer will be hard-pressed to grow its top line by more than 1% or 2% over the long-term. For what it's worth, though, every incremental 1% of growth is worth about $2 per share in my discounted cash flow model.
Speaking of cash flow, the company's free cash flow conversion rate has trailed off in recent years, which makes me wonder if the company can sustain a free cash flow margin in the high 20%s, or whether it's likely to come down back to the mid-20%s. Interestingly enough, the difference here too is about $2 per share, holding revenue growth constant. All told, though, I'm looking for free cash flow growth to putter along at roughly 2% or so absent a major deal or restructuring of the company.
That sort of growth expectation drives a per-share fair value in the high $20s (around $27.50). Given that the stock is above that price as of this writing, I can't really strongly recommend buying Pfizer shares, though I think it's a relatively safe long-term holding.