Is Pfizer's Dividend Overpriced?

| About: Pfizer Inc. (PFE)

Pfizer Inc. (NYSE:PFE) is a research-based, global biopharmaceutical company. It has a diversified global healthcare portfolio that includes human and animal biologic and small molecule medicines and vaccines, as well as nutritional products and many of the world's best-known consumer healthcare products.

The company recently announced an agreement to sell its Nutrition business to Nestle for $11.85B in cash. Pfizer also plans to spinoff its Animal Health division through an IPO over the next month.

Pfizer has consistently paid out a dividend to its shareholders over the past decade. However, the company has delivered poor dividend growth, with a compounded average growth rate of ~5%.

Clearly the dividend has been affected by the cash payment and stock dilution associated with Pfizer's acquisition of Wyeth. Going forward, Pfizer may prove to be a good dividend growth stock, but the current data shows that it has been a poor dividend growth investment for the past ten years.

Year Dividend Growth Rate
2002 $0.52 --
2003 $0.60 15%
2004 $0.68 13%
2005 $0.76 12%
2006 $0.96 26%
2007 $1.16 21%
2008 $1.28 10%
2009 $0.80 (-38%)
2010 $0.72 (-10%)
2011 $0.80 11%

Perhaps more troubling is the free cash flow per share that Pfizer has been generating over the past eight years. From 2004 to 2006, FCF/share was basically flat. And in 2011, Pfizer still generated less FCF/share than it did in 2004.

This lack of growth in FCF/share shows in the company's payout ratio, which jumped from 27% in 2005 to 66% in 2008. For the past two years, the payout ratio has been back down to a relatively low 34%. Still, the FCF and payout ratio gives some insight into why the company's dividend growth has been sluggish.

Year FCF/Share Payout Ratio (Div/FCF per share)
2002 $1.72 30%
2003 $2.21 27%
2004 $2.84 24%
2005 $2.8 27%
2006 $2.85 34%
2007 $3.03 38%
2008 $1.94 66%
2009 $1.66 48%
2010 $2.09 34%
2011 $2.34 34%

Dividend Discount Model

In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Second, I used Pfizer's 10% dividend increase to set the dividend for 2012 ($0.88/share). I used a constant growth rate of 8% for years 2013-15, a 7% growth rate for 2016-19, and a 6% growth rate for 2020-2022. Finally, I assumed a 3% perpetuity rate after 2021.

While these may be higher than the historical average, I wanted to take into account the cash-raising divestitures Pfizer is executing on, as well as its robust pipeline and cost-savings from integrating its past few mergers. Therefore, the growth projections may seem optimistic, compared the company's past performance.

Based on these assumptions, I calculated that Pfizer's intrinsic value is $20.52 per share. At the current price of $22.14/share, the stock is fairly valued, and perhaps even slightly overvalued. Additionally, the current market price assumes that Pfizer will grow its dividend at just over 5% a year, going forward indefinitely.

Pfizer does have an array of late-phase and recently approved products that may translate into future sales, free cash flow and dividend growth. With a 4% dividend yield, perhaps investors would be better served to think of Pfizer as a bond-like income investment with an attached warrant that gives them potential upside from the equity appreciation.

However, the company is currently fairly-priced based on the dividend discount model analysis, and does not provide an attractive risk-reward opportunity to long-term, income-oriented investors. There are several other dividend growth stocks, such as McDonald's and P&G, that offer a better opportunity for the price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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