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Pfizer (PFE) reported its third quarter results before the market open on Tuesday.

Investors are cautiously optimistic as Pfizer is demonstrating cost control while its oncology drugs continue to show rapid revenue growth.

I remain on the sidelines. Shares have already risen by a quarter this year on restructuring efforts, cost control and a built-up in the pipeline. Management still has a lot to show for to convince me after the 2009 deal with Wyeth is still depressing shareholder returns.

Third Quarter Results

Pfizer generated third quarter revenues of $12.64 billion, down 2.4% on the year before, thereby slightly missing consensus estimates at $12.70 billion.

Adjusted earnings rose by 2.8% to $3.86 billion as adjusted diluted earnings per share rose by eight cents to $0.58 per share on the back of sizable share repurchases. Adjusted earnings beat consensus estimates by two pennies.

Reported net earnings fell by 19.3% to $2.59 billion. Diluted GAAP earnings fell by four cents to $0.39 per share.

CEO and Chairman Ian Read commented on the third quarter performance, "Overall, I am very pleased with our continued and steady progress, on many fronts, to drive greater value for our shareholders. We continue to generate solid financial results on an operational basis, despite the impact of product losses of exclusivity and the ongoing expiration of the Spiriva collaboration in certain countries as well as the challenging operating environment."

Looking Into The Results

The reported 2.4% fall in revenues is almost entirely attributable to the impact of unfavorable exchange rate movements. Strength in emerging markets and oncology were offset by soft performance of the primary care business, driven by poor Lipitor sales.

Gross margins fell by 15 basis points to 82.8% of total sales. Selling, general and administrative expenses fell modestly to 26.5% of sales. R&D investments fell by 135 basis points to just 12.8% of total sales.

In terms of individual drug sales, it was notably oncology drugs which spurred 26% revenue growth in that unit on the back of demand for Inlyta and Xalkori. Pfizer's top selling drug Lyrica, which addresses nerve pain, reported a 10% increase in revenues, totaling $1.13 billion.

Once top selling drug Lipitor continues to see more pressure, with revenues falling by 29% to $533 million, which is worse than expected. Note that Pfizer started to face generic competition back in 2011 already for this drug. Xeljanz generated sales of $35 million, compared to no contribution last year.

And Ahead

For the full year of 2013, Pfizer now sees adjusted revenues of $50.8 to $51.8 billion. Adjusted earnings are seen between $14.8 and $15.2 billion.

GAAP earnings are now seen between $3.05 and $3.15 per share, down from a previously guided $3.07 to $3.22 per share.

Adjusted earnings are seen between $2.15 and $2.20 per share, while Pfizer previously saw adjusted earnings between $2.10 and $2.20 per share.

Valuation

Unfortunately, Pfizer didn't provide a balance sheet yet in its third quarter earnings report. The company ended the second quarter with $33.7 billion in cash and equivalents. Total debt stood at $36.7 billion, for a relatively modest net debt position of $3.0 billion.

Revenues for the first nine months of the year came in at $38.0 billion, down 7% on the year before. Adjusted earnings fell by 6% to $11.6 billion as GAAP earnings more than doubled to $19.4 billion.

Trading around $31 per share, the market values Pfizer at $205 billion. This values the firm at 4.0 times annual revenues and 15 times adjusted earnings.

Pfizer currently pays a quarterly dividend of $0.24 per share, for an annual dividend yield of 3.1%.

Some Historical Perspective

Over the past decade, investors in Pfizer have seen zero capital gains and have relied fully on dividends for any return on their investment.

Actually back in 2004, shares were still trading in their thirties to see shares slowly, but gradually fall to lows of $12 in 2009. Ever since, shares have seen upside again as the pipeline is looking healthier, prompting shares to gradually recover to current levels around $30 per share.

Between 2009 and 2012, Pfizer has grown its annual revenues by a cumulative 20% to $59.0 billion. Underlying earnings rose by a billion towards $9.5 billion in the meantime. Note that growing operations were mainly on the back of the $68 billion acquisition of Wyeth back in 2009, as revenues stand to fall again in 2013 following the divestiture of animal-health business Zoetis (ZTS) earlier this year.

Investment Thesis

Investors are cautiously optimistic following the earnings reports which shows cost control and solid growth at Pfizer's oncology drugs. Oncology has been a focus point for Pfizer with the introduction of Xalkori and Inlyta. Oncology drugs are widely seen as those having great potential in the wider pharmaceutical sector.

Also note that back in July, Pfizer announced plans to separate its operations into three separate businesses being the Global Innovative Pharmaceutical business, the Global Vaccines, Oncology and Consumer Healthcare business, as well as the Global Established Pharmaceutical business.

This break-up in separate in-house units aims to provide greater transparency of each business profitability, thereby raising speculation about possible divestitures or outright sales of large portions of Pfizer's underperforming businesses.

Cost control, a fuller drugs pipeline and rumors about a separation of the businesses or restructuring of the entire company have already pushed shares up by some 24% so far this year. Some of Pfizer's focus drugs currently in product development include Prevnar, Eliquis and Duavee, each targeting large potential markets.

These actions combined with large payouts to shareholders have re-ignited some enthusiasm so far this year. Pfizer has already repurchased $13.1 billion worth of its own stock year to date, aiming to repurchase some $15 billion of its stock this year. On top of that comes $6.5 billion in annual dividends. Combined payouts are equivalent to nearly 10% of Pfizer's market capitalization.

Almost a year ago, back in November of 2012, I last took a look at Pfizer's prospects. Shares were trading around $24 at the moment as I concluded that the company was still cleaning up after the mega deal with Wyeth, which was applauded at the time for "diversification" benefits, with 70% of drug sales expiring within five year's time. Now Pfizer believes it has not enough focus and accountability within each business segment, causing it to "restructure" again. Note that Pfizer already sold its baby food unit to Nestle for $11.8 billion last year, while it sold a stake in Zoetis, through a public offering earlier this year.

A year ago, I concluded to applaud Pfizer's strategy to focus and increase accountability through its organization, after the growth strategy over the past decade has been a failure, leaving investors with an underperforming investment.

So far investors have been faring a bit better over the past year as Pfizer used proceeds from divestments to please shareholders, notably through repurchases. At the same time, I remain cautious given the history of the company. That being said, the focus strategy, divestments or outright sales could each create more upside from current levels, it is just that management still has to convince me.

Source: Pfizer - Oncology, Focus And Pipeline Are Value Drivers Going Forward