In previous reports, we discussed that Pfizer's (PFE) declining drug sales for key products (e.g. Lipitor) would impact its revenues for 2012. We also discussed how newly approved drugs would eventually contribute to future revenue growth. In this report, we provide our forecast for Pfizer's financial projections and estimated earnings from 2013 to 2016 (see Table, Income Statement and Earnings Projection). Using our projected earnings and free cash flow numbers, we derive an estimated fair value for PFE around $28. While the stock is currently traded close to its intrinsic value, Pfizer's 3.5% dividend yield and its commitment to dividend payouts and share repurchases should still make the stock appealing to income investors.
Sales and Revenues
The patent expiration or lost exclusivity of Pfizer's best-selling drugs such as Lipitor and Effexor have caused a decline of over $7B (or -40%) in revenues in 2012. We estimate that the revenue from these drugs will continue declining to $5.6B in 2016. Newly approved drugs, such as Prevnar-13, Sutent, Inlyta, Xalkori, Xeljanz (Tofacitinib), Eliquis, Bosutinib, and Tafamidis will contribute the majority of revenue growth going forward. The estimated total revenues for Pfizer are $60B, $61.4B, $62.8B, and $64.3B from 2013 to 2016. Based on our revenue projections, PFE's revenue compound annual growth rate (CAGR) is less than 3%.
Expenses and tax
Pfizer has issued its 2013 guidance which includes estimates for some of the expenses. Its cost of goods sold (COGS) and selling and general administration (SGA) expenses are about 20% and 29% of net sales, respectively. We estimate that other expenses, including research and development expenses, depreciation and amortization, and restructuring and acquisition related charges, will be approximately $15B. PFE's 2013 effective tax rate will be 28%.
Interest income, debt, and interest expense
Interest expenses were derived from our projected debt and interest schedules. Overall, PFE's long-term debt balance will range from $30B to $33B, while short-term debt is expected to be about $2.5B. The average interest rate for Pfizer's debt is approximately 4.8%.
Overall, PFE has a strong balance sheet. Over the next four years, PFE could maintain a total debt ratio in the 20-22% range, even with the $4B debt issuance for the Zoetis (ZTS) IPO in 2013. Since Pfizer still owns 80% of Zoetis, it is likely that Zoetis' assets and liabilities will still be integrated into Pfizer's balance sheet. At present, Zoetis has $5.2B in total assets, $1.94B in liabilities, and $3.3B in equity on its balance sheet.
Net income and EPS
Our income statement projects earnings from 2013 to 2016 at $10.7B, $11.3B, $12.0B, and $12.7B, respectively (See Table, Income Statement and Earnings Projection). Pfizer's minority interest in 2013 will include 20% of Zoetis' net income that Pfizer does not own. Thus, approximately $80 million (from an estimated $400 million net income of Zoetis in 2013) will be subtracted from Pfizer's after-tax net income.
With 7,500 million diluted shares currently outstanding and assuming PFE continues to buy back $5B in shares per year, the earnings per share (EPS) for PFE will be $1.41 (2013), $1.54 (2014), $1.68 (2015), and $1.84 (2016). Pfizer also reports adjusted earnings by adding back non-cash charges, restructuring costs, and one-time items. Thus, the adjusted earnings estimates will be approximately $2.23 (2013), $2.38 (2014), $2.54 (2015), and $2.73 (2016).
Cash flows from operations (CFO)
Pfizer's cash flow from operations were $16.6B (2009), $11.4B (2010), and $20.2B (2011). Our projected cash flows from operations from 2013 to 2016 are $14.2B, $15.0B, $16.0B, and $16.8B, respectively.
Capital expenditures are $1.5B to $1.8B, representing an average of 11% of CFO. We will use these numbers to calculate free cash flow for the purposes of stock valuation (see below).
Dividends and stock repurchases
PFE's management has been actively returning cash to shareholders in the form of increasing dividend payments and share repurchases. In our projections, we assumed that Pfizer would increase its dividend by 7% (~$7.3B cash dividend in 2013) and buy back $5B worth of common stock every year. Therefore, the combined cash requirements are $12B-$14B from 2013 to 2016. Based on its operating cash flows of $14B-16B, Pfizer is essentially paying out 80%-85% of its cash from operations to investors.
Summary of financial ratios and growth rates
Based on its previous 3-year averages, PFE's gross profit margin, earnings-before-tax (EBT) margin, and net profit margin are 78%, 48%, and 15%, respectively. Its average return on equity (ROE), return on assets (ROA), and return on invested capital (ROIC) are 11.6%, 5.5%, and 25%, respectively. Overall, these ratios suggest that while Pfizer has great operating efficiencies, its profitability based on ROA and ROE are within the industry average.
PFE's debt is about 20% of its capital structure, with an interest coverage ratio of 17x, suggesting that the company is financially sound.
Pfizer's cash and short-term investment balance could increase from $37B to $41B between 2013 and 2016.
We used three models to derive an intrinsic value for PFE's stock.
(I) Using different P/E multiples, we estimated the stock prices below. With a P/E of 15, the stock's target price is $21 based on 2013 earnings. Pfizer also provided adjusted earnings in which non-cash charges were added back to its reported earnings. If we use adjusted earnings, the stock's target price is $33 based on 2013 earnings with a P/E of 15.
(II) Dividend Discount Model
Pfizer's dividend per share for 2012 was $0.91. If we assume a dividend growth rate of 7% per year with $5B share repurchases that reduce share counts, we can derive stock values using the dividend discount model with varying required rates of return (R). At a 10% rate of return, PFE's current value is $33.
(III) Free Cash Flow (FCF) Discount Model
The FCF discount model utilizes the free cash flows derived from projected CFOs from 2012 to 2016 and subtracts capital expenditures estimated to be 11% of CFO. PFE's intrinsic value is ~$28, based on a revenue growth rate of 3.5% and 10% discount rate.
In summary, the P/E multiple method suggests a price target of about $21 (based on estimated 2013 reported) or $33 (based on adjusted earnings), with a 15x multiple. The intrinsic values derived from both the dividend discount and free cash flow models are $33 and $28, respectively. At the current price level of $27, PFE stock is trading close to its intrinsic value. Nonetheless, Pfizer's 3.5% dividend yield and its commitment to dividend payouts and share repurchases could be an appealing proposition for income investors.