Over the past few weeks I have been watching the developments of the pharmaceutical industry, which has provided an excellent opportunity to search for investment stocks in this sector. One company I think is very interesting to analyze is Pfizer Inc. (NYSE:PFE). As the world's largest pharmaceutical firm, it earns over $50 billion in sales, 90% of which is attributable to prescription drugs like Viagra and Lyrica.
While the company lost its patent for Lipitor, the Lyrica and Prevnar drug sale increases have been able to offset any major losses throughout 2013. Furthermore, the recent cancer treatment product launches and the cardiovascular drug Eliquis have shown solid signs of profits and will probably drive strong growth looking forward. In addition to this, the pharmaceutical giant has the largest economy of scale in the industry, granting it a wide economic moat.
Now, while there are many different factors to look at and consider when investing, in the article below I will look at the debt side of this company. Not only will I analyze Pfizer's total debt, total liabilities, and debt ratios, but I will also look at what analysts and other top investors believe about this pharmaceutical company. From this analysis we should get an idea if the company is highly leveraged and how much to expect in return for investing in it over the long term. It is essential to remark that gaining knowledge about Pfizer's debt and liabilities is a key component in understanding the risk of investing in it.
Total Debt to Total Assets Ratio
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing this figure by the company's total assets. A debt ratio greater than 1 shows that a company's debt surpasses its assets, while a debt ratio below 1 indicates that a company has more assets than total debt.
Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk. And investors should remain calm, because as this figure is currently well below 1x (0.23), Pfizer faces low financial risk, as it has more assets than total debt.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity, if above 0.5 then the company's assets are likely financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged", meaning they face certain danger if creditors start to demand repayment of debt.
Given that Pfizer's 2013 TTM ratio surpasses the 0.50 mark, we can assume that most of the company's assets are financed through debt. Moreover, as the figure grows, so does the risk of investing in this firm.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. It measures how much suppliers, lenders, creditors and obligators have committed to the company, versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, which can result in the company reporting volatile earnings. In general, a high ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
Pfizer's debt-to-equity ratio has fallen over the past three years. As it acquired a value of 1.25 throughout 2013, compared to 1.28 in 2011, the company has ameliorated its balance sheet and risk profile. However, I must emphasize that the company's ratio of 1.25 -which surpasses 1x- implies that it faces high risks, and so do its investors. When analyzed, this figure entails that shareholders have invested more than suppliers, lenders, creditors and obligators.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which the company is using its equity to support operations and growth, thereby helping in the assessment of risk. Companies with a high capitalization ratio are considered to be risky, because if they fail to repay their debt on time, jeopardy of insolvency increases significantly, making it very difficult to get more loans in the future.
Over the past three years, Pfizer's capitalization ratio has decreased from 0.34 to 0.30, which implies that the company has more equity compared to its long-term debt, meaning it can support its operations and add growth through its equity. This is a very positive sign, and moreover, a decreasing ratio implies a slight reduction in the company's financial risk (which is, actually, quite low).
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. It provides an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company will be able to maneuver rough economic conditions.
As Pfizer's ratio currently stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.
I also evaluate recent institutional activity in the stock. In other words, which hedge funds bought the stock in the past quarters. When it comes to Pfizer, prominent investors Jim Simons and Robert Bruce bought the stock in the past quarter, at an average price of $30.22, which is quite encouraging.
Furthermore, several analysts expect Pfizer to perform well over the upcoming years. Analysts at Yahoo! Finance, for example, expect the pharmaceutical to retrieve an EPS of $2.27 for the current fiscal year and an EPS of $2.36 for the next fiscal year. Analysts at Bloomberg, on the other hand, estimate that revenue will decrease by 2.5%, with this year's $50.06B dropping to $49.54B for the next one. Nevertheless, on 4/02/2014, Jefferies gave Pfizer a rating of "Buy" with a target price of $33.88, implying significant upside potential from this point.
While some aspects of Pfizer's balance sheet bear improving, I believe investors are looking at a solid industry leader in this case. Not only is the company's scale and drug portfolio unmatched by any other rival, but its commitment to post-approval studies provide the salesforce with significant data, applicable in marketing campaigns. While this is fundamental in improving the company's image and gaining customers in the domestic market, the strong presence in emerging markets like China, Russia, Brazil, and India is bound to offset profit gains, as wealth increases at a fast pace. I also wouldn't worry too much about blockbuster drugs' patent expirations, as I'm confident that Pfizer will keep launching new products to offset these headwinds. Therefore, I feel overall bullish about this pharmaceutical giant's long-term profits and see it as a smart investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.