On December 3, 2013 Seeking Alpha's "Market Currents" released this news.
- Goldman (GS) removes Pfizer (PFE) from its Conviction Buy list.
- "We have long been advocates of the PFE breakup/ spin story [and although] we continue to expect PFE to move down the path of a full break up by 2017 (announcement likely in 2015/2016), we no longer see our call as out of consensus," analyst Jami Rubin says.
- PFE is now Buy-rated. Price target is $35.
- Meanwhile, AbbVie (ABBV) is lifted to Conviction Buy, price target $60.
- "With an $18B revenue base, ABBV has more pipeline leverage than most other mid-sized biopharma peers and is entering a long period of robust clinical trial read-outs beginning Q4," Rubin notes.
Regardless of whether you are a fan of Goldman Sachs' research or not, no one can deny that its analysts' comments have a great effect on the markets. I am always interested in seeing how my free cash flow analysis compares with Goldman's and the following is an analysis of Pfizer and AbbVie in order to do just that.
This analysis will use the following six free cash flow ratios:
- Price to Mycroft Free Cash Flow
- Mycroft/Michaelis Growth Rate
- Free Cash Flow Payout Ratio
- Free Cash Flow Reinvestment Rate
Those new to this analysis can find an introduction by going here that will explain in detail how each of these ratios is calculated. When used together, these unique ratios will generate a quantitative picture of a company's underlying fundamentals, including strengths and weaknesses.
The "2014 Mycroft Free Cash Flow Per Share" estimate, shown in the table above, is generated by taking the trailing twelve months (TTM) free cash flow result for both Pfizer and AbbVie and then adding the Mycroft Michaelis Growth Rate into the equation in order to generate forward looking estimates for 2014. That growth rate is generated by using my FROIC ratio (Free Cash Flow Return on Invested Capital). FROIC enables one to determine how much free cash flow is generated for every $1 of total capital employed.
Pfizer has a FROIC of 14%, which means that for every $100 of invested capital, the company generates $14 in free cash flow. AbbVie on the other hand has a FROIC of 30% and thus generates $30 in free cash flow for every $100 of invested capital.
Now the Mycroft/Michaelis Ratio takes the FROIC for each company and multiplies it by the firm's free cash flow reinvestment rate. The reinvestment rate that I use is a free cash flow reinvestment rate instead of the standard one used by analysts that simply uses net income. I calculate it as follows:
Free Cash Flow Reinvestment Rate = 100% - (Free Cash Flow Payout Ratio).
Free Cash Flow Reinvestment Rate = 100% - (Total Dividend/Total Free Cash Flow).
By replacing net income in the payout and reinvestment ratios with free cash flow, I am thus able to make my analysis more precise by incorporating capital spending (Cap Ex) into the equation.
Therefore from this we can determine that:
Pfizer has a reinvestment rate of 58% and went on to use 42% of its free cash flow to pay out its dividend. Thus by taking 14% (FROIC) x 58% = 8.12% (rounded off to 8%). From there we add the dividend yield of 3% and we have a Mycroft/Michaelis growth rate of 8% + 3% = 11%.
AbbVie, interestingly enough, also has a reinvestment rate of 58% and went on to use 42% of its free cash flow to pay out its dividend. Thus by taking 30% (FROIC) x 58% = 17.4%. From there we add the dividend yield of 3.3% and we have a Mycroft/Michaelis growth rate of 17.4% + 3.3% = 20.7% (rounded off to 21%).
Pfizer's Mycroft Free Cash Flow per share of $2.53 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 11% or 1.11). Once we have our result, we then take its current market price of $31.22 and divide it by $2.53 and get a Price to Mycroft Free Cash Flow result of 12.34.
AbbVie's Mycroft Free Cash Flow per share of $4.67 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 21% or 1.21). Once we have our result, we then take its current market price of $49.97 and divide it by $4.67 and get a Price to Mycroft Free Cash Flow result of 10.70.
I consider a Price to Mycroft Free Cash Flow per share result of less than 15 to be good for purchase, and anything under 7.5 to be excellent.
The higher you go above 15, the more overvalued a company becomes. I use a Price to Mycroft Free Cash Flow per share result of 22.5 as my sell price, and 45 as my short price.
An appropriately priced stock should trade around a Price to Mycroft Free Cash Flow per share result of 15. This benchmark result was determined by backtesting.
Buy (opinion) = A Price to Mycroft Free Cash Flow per share result of less than 7.5 is considered excellent (50% below the initial Hold level), and anything under 15 is attractive.
The result I give as my Buy opinion in the table above uses a Price to Mycroft Free Cash Flow per share result of 7.5.
Hold (opinion) = 15 to 22.5 (I use 15 in the table).
Sell (opinion) = 22.5 or higher (50% above the initial Hold level). (I use 22.5 in the table).
Short (opinion) = 45 or greater. The Price to Mycroft Free Cash Flow per share result of 45 was determined by going back to the peak of the market (in the year 2000) and averaging the Price to Free Cash Flow per share results for the key players at that time. (I use 45 in the table).
The CapFlow ratio results that you see in our first table above is an original ratio I created in order to tell me how much Capital Spending is used as a percentage of Cash Flow. A result of less than 33% is considered ideal.
Pfizer coming in at 8%, means that 92% of the company's cash flow is actually free cash flow and can be used for such things as buying back stock. AbbVie coming in with a CapFlow of 4%, means that 96% of the company's cash flow is free cash flow.
In conclusion, both companies have excellent results using my system. With such incredible CapFlows both companies have superior cost controls in place and have little need in the way of capital expenditures in order to grow operations. If you look at the article that Seeking Alpha linked to in order to generate its "Market Current" you will see this in the first paragraph:
"Goldman Sachs downgraded Pfizer (NYSE: PFE) from Conviction Buy to Buy with a price target of $35.00 (from $34.00). AbbVie (NYSE: ABBV) was raised to Conviction Buy and its price target was raised to $60 (from $57)."
As you can see Goldman Sachs downgraded Pfizer but still kept a buy rating on it. My research agrees with Goldman's conclusions and also picks AbbVie over Pfizer as AbbVie has twice the performance numbers and half the CapFlow that Pfizer does. I have not bought either of these stocks for my client portfolios as of yet, because I am waiting for the problems with ObamaCare (Affordable Care Act) to be resolved and determine how it will impact each of these companies.