There is no point in asking if a Big Pharma company will go through its trial by fire (or trial by patent cliff, if you prefer), it's just a question of when. Although Pfizer (NYSE:PFE) is not exactly in the clear with all of its patent cliffs, most of the damage has been done and Pfizer has emerged as a leaner, more profitable, and ultimately more interesting major drug company.
Decent Results For Q4
Some of the company's progress shows through in fourth quarter results. Revenue was down 5%, but still fared better than most analysts expected. Certainly the drug business needs more help; revenue was down 6% as reported, with U.S. sales down 15% due in large part to declining sales of Lipitor (now off patent). Ancillary businesses were fairly strong though, as animal health grew 13%, consumer products grew 8%, and nutrition grew 22%.
Pfizer has also made considerable progress in its profitability. Gross margin rose almost a point and a half to 79.9%, while operating income rose 9% and exceeded expectations. Compare Pfizer's profitability these days to the likes of other drug companies like Lilly (NYSE:LLY), Merck (NYSE:MRK), and even Bristol-Myers (NYSE:BMY) and Pfizer looks pretty solid.
The Pipeline Is Still A Weak Point
There's good news and bad news when it comes to Pfizer's pipeline. The bad news is that a considerably smaller percentage of Pfizer's 2018 revenue is projected to come from products in the pipeline today relative to others like Lilly or Bristol-Myers. To some extent that means that the company has moved past the worst of its patent losses, but it also means there aren't so many high-potential products coming relative to existing sales.
The biggest drugs to watch are tofacitinib and Eliquis. Tofactibinib is the company's oral JAK inhibitor for rheumatoid arthritis. Although there have been some safety worries on the drug (particularly relating to infections), the efficacy should be sufficient for at least second-line use. Given that 20-40% of patients fail on TNF drugs like Abbott's (NYSE:ABT) Humira (or Pfizer's own Enbrel) and the market is worth about $12 billion, that's still ample potential.
For Eliquis (partnered with Bristol-Myers), the potential is likewise about $2 billion competing primarily in the atrial fibrillation market against Boehringer Ingelheim's Pradaxa and Johnson & Johnson's (NYSE:JNJ) Xarelto. Behind this are multiple other late-stage programs (25 total compounds in Phase 3 studies) and some, like dacomitinib in lung cancer, axitinib in renal cell cancer, and bosutinib in leukemia, have solid if not spectacular sales potential.
It should be noted that JNJ and Pfizer are also partnered together on a late-stage drug in trials for Alzheimer's. Superficially similar to Lilly's solanezumab, bapineuzumab is a low-probability/high-potential drug that will likely fail, but would certainly represent meaningful upside if Phase 3 studies show efficacy.
Time To Do Something Big?
I do wonder if Pfizer might consider another major move. Though the company has a relative stable revenue outlook, the pipeline is quite weak (Lilly arguably being the only weaker U.S.-based Big Pharma pipeline). In contrast, Bristol-Myers has arguably the best pipeline, but quite a lot of revenue at risk in the coming years from patent expirations.
Surely this would be a major move to contemplate (Bristol-Myers is roughly one-third the size of Pfizer by market cap), but the deal for Wyeth largely seems to have paid off. Moreover, funneling even more sales through the existing infrastructure and firing even more scientists and sales reps would produce pretty powerful margins and cash-on-cash returns.
And it's not as though Pfizer is hurting for funds. Disposing of the nutritionals and animal health businesses could generate about $25 billion in total and perhaps another $6 billion to $8 billion could be had if Pfizer chose to liquidate its remaining consumer care business (including brands like Advil and Centrum). Though Pfizer may just opt to continue share buybacks and the occasional smaller tuck-in deal, a big swing wouldn't shock me.
The Bottom Line
After a long run of disappointing underperformance, it looks like Pfizer has its house in order. Although the pipeline prospects are not great, the risk is less than with many Big Pharma companies and the company's sitting much better vis a vis patent expirations. What's more, a long program of restructuring and cost cutting has resulted in some pretty impressive margins and free cash flow conversion.
I expect Pfizer to offer up less than 3% compound free cash flow growth over the next decade, which may actually seem a little aggressive given the recent trajectory of revenue growth. Nevertheless, that ultimately fuels a price target in the high $20s and combined with a 4%-plus dividend yield, this looks like a very interesting dividend growth play for more conservative or value-oriented investors.