Rule no.1: if a company is doing fine, look at the balance sheet.
Rule no.2: if a company is in trouble, see Rule no.1.
Pfizer, the world leading drug maker has find a place in many of the major value managers portfolios. According to GuruFocus, below is a table of the most famous investors involved:
Two main reasons that convinced them (and us) to invest in Pfizer stock: historical low P/E multiples and a AAA graded balance sheet. The latter is most important for us. Pfizer has about $14 billion cash and short term investments and only 8 billion of short and long term debt. It has got one of the strongest balance sheets in big pharma industry with a debt to equity ratio of 0.116.
The balance sheet is almost always overlooked by stock analysts but is paramount to protect your investment's value especially in case of a disaster.
The company faced a true disaster yesterday. A few days after an analyst meeting with a very positive tone on their drug pipeline, but after high death rate statistics of patients in clinical trials, Pfizer decided yesterday to stop trials of the anti-cholesterol drug torcetrapib.
This sudden and unexpected stop is a major drawback for the company's future since torcetrapib was supposed to replace Pfizer's best selling drug, Lipitor, whose patent expires in 2010. In the last twelve months Lipitor amounted to about a quarter of all Pfizer's sales and now suddenly for which there is no replacement.
What would have happened to a more levered company ? An immediate crash of 20/30% would have been in the cards.
In the case of Pfizer, the balance sheet's strength can somehow freeze the slide. Ample cash at their disposal will allow management to put a floor on the stock by:
- increasing dividend (already at 3.40%)
- buying back shares
- investing in drug pipelines developed by other companies
In fact, despite abysmal news, the stock closed yesterday at $24.82, "only" down around 11%.
So what to do with stock now ?
We sold our 50% position bought at $24.79 in December 2004 at a 2.6% loss. Including dividend the investment has been barely positive.
According to Value Investor Blog the main danger is now that cash on hand will be used to buy some missing pipeline at a hefty price either by purchasing drugs from other pharmaceuticals companies or by merger and acquisitions operations at unfavourable terms for current Pfizer shareholders.
We must admit however, that so far the new CEO, Jeffrey Kindler, has impressed us in his first months of tenure. He is aggressively cutting costs to adapt Pfizer's structure, he's trying to shake up stagnant revenues and he's expressed a strong commitment to dividend increases and share buybacks.
If he starts to make the right moves to solve Pfizer's poor research and development productivity by wisely using cash in hand, Pfizer could become an attractive investment again-- if the balance sheet remains strong, of course.
Investors already long the stock may keep it in hand, or at least part of their position and wait for a turnaround in the company pipeline while cashing in on a juicy dividend. The risk is that Pfizer will become dead money for a few years.
We believe the rock bottom of the stock is limited $20-21 / share if no major negative event impacts the company. At this level we would consider buying in to the stock again.
PFE 1-yr. chart
Disclosure: At the time of posting the author did not have a position in Pfizer.
Related Articles: Searching for Value Investments in the Drug Stock Universe; Pfizer Failed: So What?; Pharmaceutical Losses: Thinking Through Pfizer and Merck; New Directions in Healthcare Investment: Is The Age of Pharmaceutical Companies Over?; Pfizer Post-Torcetrapib: Follow The Cash -- And Abbott; Simply Tragic: Pfizer's Torcetrapib Cholesterol Drug Halted