With all of the M&A discussions surrounding drug giants Pfizer (NYSE:PFE) and AstraZeneca (NYSE:AZN), investors appear broadly indifferent about Pfizer's earnings announcement Monday. Although the results weren't Pfizer's best in absolute terms, they did support my belief that prior fears about Pfizer's pipeline were exaggerated. Even more important, Pfizer was able to bolster its balance sheet, which was already impressive to begin with. With AstraZeneca looking for a sweeter deal, Pfizer's management has even more firepower to close this deal and inject itself with the growth it needs.
First-quarter revenue declined 9% year-over-year to $11.4 billion, missing Street estimates of $12.4 by 5%. As much as I like this company, I don't mind admitting that this was a pretty sizable miss. But it wasn't surprising that this was due to weakness in some of Pfizer's older drugs, including Lipitor, Viagra and Lyrica. We can't discount the effect of Celebrex, one of Pfizer's most lucrative arthritis drugs.
Recall, several months ago, a federal court rejected a key patent for Celebrex, which is used to treat illnesses related to osteoarthritis, rheumatoid arthritis and juvenile rheumatoid arthritis. Celebrex generated roughly $3 billion in revenue in 2013, and ranks as Pfizer's fourth-best selling product. Even more impressive is that the drug has the potential to exceed gross margins of 90%.
Assuming that Celebrex receives regulatory approval, which is under appeal, Pfizer will be able to earn almost $1 for each dollar it generates in revenue. So that's looking ahead to the future. So, despite the 6% miss in revenue, I see this as temporary setback.
From an operational perspective, management did what it had to do to generate profits. Net income for the quarter came in at $2.3 billion, a 15% decline year-over-year. But on an adjusted basis, excluding special items (like the non-recurrence of income from the company's discontinued animal health segment), Pfizer posted a profit of $3.7 billion, or 57 cents per share, which was enough for a 2-cent beat, according to most estimates. Once again, management showed incredible margins within its mix. Gross margins improved 0.40%, beating estimates of a decline of 2.1%.
Note, with all of the negotiations going on with AstraZeneca, which Pfizer first offered to buy back in January, Pfizer management advised that under UK Takeover Code, it is not permitted to confirm or update its full-year 2014 guidance. But back in January, management offered a full-year earnings range of $2.20 to $2.30 per share. But investors shouldn't assume that these figures are still valid, given all of what has transpired up to this point, including the patent news regarding Celebrex. During the announcement, Ian Read, Pfizer chairman and CEO offered:
Despite continuing revenue challenges due to ongoing product losses of exclusivity and co-promotion expirations, I look forward to the remainder of the year given the strength of our mid- and late-stage pipeline, the continued growth opportunities for our recently launched products as well as opportunities for upcoming product launches.
Accordingly, Pfizer investors have more reasons to be optimistic. Management seems committed to pursue revenue growth opportunities it feels will present long-term value to shareholders. And despite the noticeable weakness in the pharmaceutical businesses, there are very few drug companies that have balance sheets that are as healthy as Pfizer's.
To that end, it's just a matter of time before Pfizer and AstraZeneca come to terms with their deal, which Pfizer just raised from $100 billion to roughly $106 billion, $84.47 in U.S. dollars. As it stands, with Pfizer's stock trading at a P/E of 9, these shares are still cheap. With improved cash flow and strong margins, these shares should trade at $40 by the end of this year. And assuming the company lands AstraZeneca, I'm projecting shares to reach $45, on the basis of AstraZeneca's revenue growth and margins.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Wall Street Playbook's healthcare sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.