In terms of earnings growth today, Pfizer (PFE) is just a middling Big Pharma pick. On a longer-term basis, though, it looks as if the Street is still undervaluing the company's ability to continue to earn strong economic profits and return capital to shareholders. While the near-term news flow has not been great and the company will be hard-pressed to post major earnings growth without a large transaction, there is still value here for the patient shareholder.
Good Operating Performance in Q2
Pfizer did a respectable job for its fiscal second quarter. Revenue dropped 9% as reported and 6% on an "operational" basis, as the loss of mega-drug Lipitor sent U.S. sales down 15%. Within Pfizer's roster of drugs, Lipitor is still No. 1 at over $1.2 billion, even with a 53% year-on-year decline. Lyrica, Prevnar, and Enbrel continue to perform well, though, growing from 14% to 8% from last year and each contributing nearly $1 billion in revenue. In all, this puts Pfizer in the middle of the Big Pharma pack, certainly well short of Roche (RHHBY.PK) and Merck (MRK) -- which both had growth -- but well ahead of the high-teens revenue erosion of AstraZeneca (AZN) and Bristol-Myers (BMY).
Pfizer did better than average from an operational standpoint. Gross margin improved a point and a half from last year, with operating income rising 1%. Despite a significant upcoming drug launch and a fairly deep pipeline of Phase III studies, Pfizer nevertheless cut SG&A and R&D spending by nearly 20% each.
Clinical Setbacks -- Death by a Hundred Paper Cuts?
Pfizer has not had an abundance of great news from its pipeline recently. The company's would-be Alzheimer's drug bapineuzumab -- shared with Johnson & Johnson (JNJ) and Elan (ELN) -- is looking extremely shaky after the first of four Phase III studies. Eliquis (partnered with Bristol-Myers) has gotten held up the FDA. Vyndaquel, the company's entry into the TTR-FAP orphan drug market, was also rejected by the FDA, and the company has ended a few drug development partnerships over the last four months.
None of these are earth-shattering. Very few investors expected much from bapineuzumab, and Eliquis is almost certainly going to get to market at some point (and problems with Johnson & Johnson's Xarelto aren't doing Pfizer any harm). The Vyndaquel setback likely does not meaningfully change the long-term fair value on the shares, and the company likely ended those development partnerships as they saw little potential for meaningful return on future capital commitments.
The thing is, sooner or later these setbacks start adding up. A few hundred millions of dollars here and a few hundred millions of dollars there, and pretty soon you're talking about real money. FDA approval of tofacitinib (estimated in August) would be a welcome development, and investors should not lose sight of the multiple multi-hundred-million-dollar drugs in the pipeline (particularly in oncology).
Big Pharma, But no Big Growth
The bad news for Pfizer investors is that the Street has a dicey history of rewarding no- to low-growth stories, and it is difficult to see how Pfizer's pipeline will produce enough growth to really move the needle. Eliquis should be a multibillion-dollar drug, as should tofacitinib, and there are a few billion-dollar babies in the clinic, but we're talking about a business with about $60 billion in annual sales.
While the operating income growth potential looks better (especially if the company can expand its vaccine business), Pfizer is unlikely to grow above a low single-digit rate unless the company pursues another Wyeth-type transaction or really strikes gold with a drug for a heretofore underserved market like Alzheimer's.
The Bottom Line
With Pfizer's difficult growth prospects are the bad news, the good news is that the Street expects even less. Just 1% free cash flow growth, something that the company could achieve with just a slight improvement in free cash flow conversion, supports a fair value close to $30. Pfizer isn't quite as appealing as Sanofi (SNY), Teva (TEVA), or even Roche in terms of undervaluation, but it's close. Pfizer remains a worthwhile prospect for investors content to see slow and steady value accretion.
Disclosure: I am long RHHBY.PK.