We have updated our financial projections and stock valuation for Pfizer (PFE) based on its 2012 annual report released on February 28, 2013. From our projected income statement (Table 1), Pfizer's revenues could grow slowly from $60B in 2013 to $65B in 2017, whereas the adjusted earnings per share (EPS) could increase from $2.35 to $2.87. Using our projected free cash flow numbers (Table 4), we derived an estimated fair value for PFE at $30. With the stock currently trading at $28-$29 range, it is fairly valued. The stock provides a 3.4% dividend yield, which should still be appealing to income investors.
The financial data for 2012 are based on the PFE 2012 annual report 022813. The most noticeable item in our projected Income Statement is the 10% decrease (~$6B) in revenues in 2012 compared to 2011. This is primarily due to the patent expiration of Lipitor and lost exclusivity of several drugs to generic competition. However, the newly approved drugs, such as Prevnar-13, Sutent, Inlyta, Xalkori, Xeljanz (Tofacitinib), Eliquis, Bosutinib, and Tafamidis will contribute to revenue growth from 2013 and going forward. The estimated total revenues for Pfizer are $60.2B, $60.6B, $62B, $63.4B and $65.1B from 2013 to 2017. This suggests that PFE's revenue compound annual growth rate (CAGR) is approximately 2%.
On the expense side, we used Pfizer's historical gross margin and EBIT margin as a guide. Its cost of goods sold (COGS) and selling and general administration (SGA) expenses were about 20% and 40% of net sales, respectively. We also estimated a 3% increase in other expenses and restructuring costs and a 22% effective tax rate going forward.
Interest expenses were derived from our projected debt and interest schedules. Overall, PFE's long term debt balance will range from $30B to $35B, while short-term borrowing is expected to be about $2.5B. The average interest rate for Pfizer's debt is approximately 5%.
Our income statement projects earnings per share are $1.53 (2013), $1.57(2014), $1.66 (2015), $1.77 (2016), and $1.88 (2017). Pfizer also reports adjusted earnings by adding back non-cash charges, restructuring costs, and one-time items. The adjusted earnings estimates will be approximately $2.35 (2013), $2.42 (2014), $2.55 (2015), $2.70 (2016), and $2.87 (2017).
Pfizer's cash flows from operations are estimated to be between $16B and $17.5B from 2013 to 2017. Capital expenditures are $1.6B to $1.8B, representing an average of 10% of CFO. Therefore, its free cash flows are in the range of $14.5B~$15.8B. The free cash flow numbers are used to derive PFE intrinsic value (see below).
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 5% (~$7.3B cash dividend in 2013) and buy back $5B worth of common stock every year. The combined cash requirements are $12B-$14B from 2013 to 2017. Pfizer could payout dividends and buyback stock using its free cash flow. In addition, Pfizer's management stated that it would continue to sell the remaining 80% of Zoetis, which had its IPO in 2012. Pfizer will return the sales proceeds to shareholders through tax-free distribution, either in the forms of dividend or share repurchases.
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 19% respectively. Its average return on equity (ROE), return on assets (ROA), and return on invested capital (ROIC) are 17.7%, 7.8%, and 20%, respectively. These ratios suggest that while Pfizer has great operating efficiencies, its profitability based on ROA and ROE are within the industry average.
Overall, PFE has a strong balance sheet. Over the next five years, PFE could maintain a total debt to total capitalization at 28%. Its interest coverage ratios are in the range of 15x-20x. This suggests that the company has the ability to service its debt.
We utilized the Discounted Free Cash Flow model to derive PFE's intrinsic equity value. Based on the free cash flow numbers from 2013 to 2017 and a long-term growth rate of 3.5%, the estimated per share stock value is ~$30. As shown in the table below, the long-term growth rate has significant impact on its value. A lower growth rate translates to a lower stock valuation. Therefore, it is important that Pfizer continues expanding its drug pipeline to enhance its revenue growth.
PFE is currently traded at $28.6 as of 3/26/2013. This price represents a 12.2x multiple to the 2013 adjusted earnings. With a 3.4% dividend yield and a management committed to returning value to shareholders, PFE is appealing to value investors who are willing to hold the stock for the long term.