Pfizer - Guides Lower Again, Uncertainty About The Future Strategy Remains

Jul.30.14 | About: Pfizer Inc. (PFE)


Pfizer's second-quarter results are more or less in line.

The company lowered the full-year sales guidance on the back of the loss of exclusivity in key drugs.

The poor track record, lack of organic growth and poor experience with past dealmaking makes me cautious.

Pfizer (NYSE:PFE) reported second-quarter results which were more or less in line with consensus estimates. Yet shares gave up some ground on Tuesday after the company lowered its full-year sales guidance.

I continue to shun the shares on the back of valuation concerns, a poor track record and the troubled history of past deal making. The solid balance sheet and dividend yield creates some appeal, but does not outweigh my concerns.

Second Quarter Headlines

Pfizer posted second-quarter sales of $12.77 billion, down 1.5% compared to last year. Despite the fall in sales, revenues came in comfortably ahead of consensus estimates at $12.46 billion. While sales were better than expected, stagnating or falling sales is a big and continued problem faced by Pfizer.

The company posted a 5.8% drop in adjusted earnings which fell to $3.77 billion. Thanks to modest share repurchases, non-GAAP earnings advanced by two cents to $0.58 per share. This implies that earnings came in a penny ahead of consensus estimates.

GAAP earnings were down by 79% to $2.91 billion, with GAAP earnings coming in at $0.45 per share.

Looking Into The Performance

CEO Ian Read was pleased with the operating performance, being happy with the performance of recent product launches and the progress in the mid- to late-stage pipeline developments. So far, the standard marketing talk in the press release, sales and operational earnings were actually down as the loss of exclusivity on some drugs outweighed the success of new ones.

At the start of this fiscal year, Pfizer has commenced reporting under its new structure which is comprised out of the global innovative pharmaceutical segment (GIP), the global vaccines, oncology and consumer healthcare segment (VOC), and the global established pharmaceutical segment (GEP). All of this should simplify the business, yet with a company the size of that of Pfizer, there is no real way to simplify the financial statements, especially not given the huge amount of drugs it is marketing at the moment.

The decline in operational profitability was throughout the income statement. For starters, there was the 1.5% drop in topline sales. At the same time, cost of goods sold rose by 10%, resulting in higher cost of sales which came in at 19.3% of sales, up 200 basis points compared to last year.

The company managed to cut selling, general and administrative expenses by 2.0%, thereby effectively containing those costs. The company did increase its R&D budget, however, by 15% to $1.76 billion, or to 13.8% of sales. Amortization charges on intangible assets were down by 12% to $1.00 billion as restructuring costs more than halved to $83 million.

As a result, operating earnings before taxes came in at $4.0 billion a 25% drop compared to last year's $5.4 billion. It must be said that last year's operating income was aided by a net gain of $1.1 billion, largely related to patent litigation settlements.

Net earnings were aided over the past quarter thanks to a lower effective tax rate of 27.1%, resulting in net earnings of $2.9 billion. Of course, earnings were down very sharply compared to last year's $14.1 billion in earnings which were aided by the $10.6 billion gain related to the sale of Zoetis (NYSE:ZTS) through its initial public offering.

More Cautious Full Year Guidance

Based on the softer results and the slightly worse prospects going forward, Pfizer now sees sales between $48.7 and $50.7 billion for the year, down $500 million from its earlier guidance. Sales are expected to suffer from the anticipated competition for Celebrex, which is anticipated in December of this year with the drug losing exclusivity at the time.

Selling, general and administrative expenses are now seen between $13.3 and $14.3 billion, $200 million less than previously anticipated. This money is ¨invested¨ into higher R&D investments of $6.7-$7.2 billion, which is $300 million more than Pfizer previously forecasted. The increase in R&D expenses relates to the acceleration of some late-stage clinical programs, including palbociclib and bococizumab.

All of this should result in reported GAAP earnings of $1.47 to $1.62 per share, ten cents less than the company has previously been expecting. The adjusted, non-GAAP earnings guidance of $2.20-$2.30 is unchanged from the year before.

Despite lowering the full-year sales guidance, the midpoint of the guidance came in ahead of consensus estimates of $49.3 billion. The non-GAAP earnings guidance is in line with consensus estimates at $2.24 per share.

Valuing Pfizer

The company did not provide a balance sheet with its second-quarter results. By the end of the first quarter, Pfizer reported having $33.9 billion in cash and equivalents on its balance sheet. Total debt of $37.0 billion results in a very modest and manageable $3 billion net debt position.

With an estimated 6.4 billion shares outstanding anticipated for the end of the year, equity in the business is valued at $192 billion at $30 per share. This values equity in the business at about 3.8 times annual revenues, 13-14 times adjusted earnings and 19-20 times GAAP earnings.

Long Term Struggles, Uncertain Future

Over the past decade, Pfizer has reported flat revenues overall at about $50 billion between 2004 and 2014's revenue projection. Revenues in 2010 jumped to $65 billion, up from $50 billion the year before after the $68 billion acquisition of Wyeth in 2009. The spin-off of Zoetis as well as lower drug sales explain the fall in sales back to the $50 billion mark.

Earnings from continuing operations have ranged between roughly $7 and $11 billion per annum over this time period, but have failed to show a meaningful trend. The only bright thing is that the company managed to reduce its outstanding share base by about 15% over this time period.

To rejuvenate topline sales growth, Pfizer of course attempted to acquire AstraZeneca (NYSE:AZN) earlier this year. The potential $118 billion deal broke down as both companies could not agree on a price. The company has not really outlined a plan whether it wants to pursue another deal, or what its plan will be for future growth.

Final Takeaway

Pfizer lacks very large block buster drugs but has great diversification in its business. The company breaks out sales results for 45 drugs, which is not even all of the products being marketed by the company. Lyrica remains the company's top-selling drug, posting quarterly sales of $1.31 billion, up 16% compared to last year. This implies that annual sales of its top-selling drug are just 10% of company-wide sales.

While this diversification is great, Pfizer's track record is not. The continued pressure on sales and the distraction of the whole AstraZeneca chapter might weigh on the operational performance in the near term. CEO Ian Read, declined to really comment on the situation citing UK takeover rules, and issued a common statement that the company is exploring all alternatives, including that of the company's future.

UK takeover rules also prevent Pfizer from making a run for its British counterpart before November of this year. Until a move is made or deal with a foreign partner is closed, Pfizer remains at a tax disadvantage at a time when competitors like AbbVie (NYSE:ABBV) are making progress in their attempt to lower their tax bill.

While I do applaud the financial health of Pfizer and the 3.5% dividend yield, the long-term track record is not very good, with shares being flat over the past decade. This is despite shares doubling from their lows of $15 during the crisis. I don't think that a quick deal which lowers taxes and buys revenues is a real fix. Rather I would like to see Pfizer focusing more on R&D and more smaller and medium sized deals to really improve the organic growth pace of the business.

As such I remain very cautious, not seeing any new facts in today's earnings report which can change my mind. I won't chase the stock at current levels, yet for current investors the 3.5% dividend yield is quite appealing, yielding a 100 basis points over Treasuries.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.