Pfizer (PFE) is not a company I have written much about in the past, primarily because I wanted to take a wait-and-see approach to how the company could manage its overall profitability following the expiration of exclusivity on the Lipitor patent. At its height, Lipitor had ten million customers that collectively generated $13 billion in annual sales, coming to represent about 17% of the company's total sales. In the past year, Pfizer has gone to great lengths to minimize the losses surrounding the patent expiration by making Lipitor available at 80% off cost and offering other subsidies and incentives to stick with Pfizer's legendary cash cow (Source).
As we look ahead going forward, I would be surprised to see Pfizer's dividend growth rate be in excess of 5-6% over the next five years or so.
The logic is that significant organic growth will be difficult over the upcoming years as the company has to replace Lipitor profits and address other upcoming patent expirations. Sales for Lipitor have gone close to 60% in the first six months since going off patent (and that is taking into account the 80% price cuts and subsidies), and Celebrex and Zyvox will be going off-patent in the next two years (2014 and 2015, respectively).
To create wealth over the medium-term for shareholders, Pfizer is relying on three things to boost the earnings per share rate experienced by shareholders:
- (1) Reductions in Capital Spending. Back in the early 2000s, Pfizer used to spend about $0.30 per share in capital spending. That figure is now down to $0.20 per share. Additionally, the company is currently reducing costs by about $1 billion annually, which allows more profit to reach the bottom-line in the immediate sense.
- (2) Expected Product Growth. Prevnar has had a bad year, with sales down 10% in the first half of 2013. Those problems are likely short-term, and Prevnar should contribute more to Pfizer's growth in the coming years. Additionally, the hope is that Eliquis and Lyrica can experience strong growth in the coming years to help offset the declines at Lipitor and the upcoming expirations with Celebrex and Zyvox.
- (3) Buybacks. To offset the difficulty in organic growth without Lipitor patent exclusivity, the company has been relentless in reducing the share count over the past three years. In 2010, Pfizer had 8.012 billion shares outstanding. In 2011, the company had 7.575 billion shares outstanding. In 2012, the share count reduced to 7.276 billion shares outstanding. In 2013, the share count came down to 6.500 billion. Much of these strong share count reductions are one-time in nature, connected to the spinoff the animal division Zoetis. With that said, the continued execution of the current buyback program ought to take Pfizer's share count down into the 6.2 billion share outstanding range next year.
Going forward, Pfizer has earnings power of roughly $12 billion in profits per year adjusting for Lipitor's decline and the upcoming patent expirations. Despite the problems inherent in seeing cash cows go off patent, the underlying business at Pfizer remains quite good, with operating profit margins approaching 50.0%. There is something commendable about the fact that Pfizer is currently operating through the tough part of its business cycle, and it's still able to generate $12 billion in profits and engage in financial engineering (defined as cost cuts and share buybacks) to stimulate earnings per share growth for shareholders.
That's why it looks like Pfizer's dividend should continue to grind forward in the coming years. Pharmaceutical companies tend to run into trouble when the payout ratio exceeds 60% of profits because that makes it difficult to engage in stock buybacks and aggressive research and development simultaneously. The implication is that Pfizer does not have much room to increase its payout ratio, but must instead maintain a dividend growth rate that should be roughly parallel to the overall earnings per share growth rate of the firm. The buybacks and cost cuts are providing an outlet for the company to put more money in the pockets of shareholders in the short term, but it is unlikely that the dividend growth will exceed 6-7% or so due to the company's current difficulties in replacing the profit losses from Lipitor.