A Contrarian Look at Pfizer

Informed opinion almost always advocates the popular course, so you must steel yourself to stand apart. To be a contrarian is to be an outsider – until you’re proven right. (David Dreman, Contrarian Investment Strategy, 1979)

Pfizer (PFE) reached a high of $48 a share in June 2000, and now trades at about $20. Twenty-one analysts are following the stock, but only six are recommending purchase. The contrarian investor in me had to take a look.

First, I put Pfizer through the Fast Track™ screen. The stock passed my rule of failing no more than three categories, so I continued to do more research using the Company Stock Risk Profile™ research tool. While Pfizer came through with a Medium Risk rating, having failed 19 of the 50 categories, the stock missed being rated Low Risk by only 2 categories.

Pfizer’s Risk Profile highlighted these negatives:

1. Pfizer is not delivering any growth, as sales have been essentially flat since 2004. Reported earnings have been extremely erratic, impacted by ongoing “purchase accounting adjustments, acquisition related costs, discontinued operations and certain significant items.” Adjusted for these items, as management does, earnings are smoother, but still are not growing. First quarter 2008 sales declined 5.0%, and reported and adjusted earnings per share dropped 12.8% and 10.3%, respectively.
2. Pfizer is being hurt by multiple patent expirations on very successful pharmaceuticals – Zithromax (antibiotic) in November 2005, Zoloft (depression) in August 2006, and Norvasc (hypertension) in March 2007. Lipitor (cholesterol) produced sales of $12.7 billion in 2007, and its patent is up in March 2010. As an example of what could happen to Lipitor’s sales, Zoloft’s sales went from $3.3 billion in 2005 to $531 million last year. Generics, as well as branded competition, already are eating away at Lipitor’s U.S. sales, which fell 8% in 2007 and 18% in this year’s first quarter.

I’m not presenting anything new here, as these issues are well known and baked into the stock price. The following positive factors also are there for investors to see, but are being overlooked:

1. Pfizer has a fortress balance sheet. The company ended the first quarter with cash and cash equivalents and short-term investments of $28.6 billion, which is up from $25.5 billion at year-end 2007 and $22.5 billion a year earlier. Long-term debt as a percentage of total capital is at a low 10.8%. And if that is not enough, net current assets (current assets less current liabilities) are more than 3 times long-term debt.
2. Pfizer remains a strong cash flow generator. Cash flow from operations was $13.4 billion last year, and after capital expenditures, free cash flow was $11.5 billion. These same numbers in this year’s first quarter were $3.3 billion and $2.8 billion, respectively. 2007 free cash flow could drop 25% and still cover the dividend. Management is forecasting operating cash flow of $17 - $18 billion this year, and expects “to continue to generate strong operating cash flow beyond 2008.”
3. Pfizer has 102 medicines in its pipeline – 47 in phase 1, 37 in phase 2 and 16 in phase 3. Two drugs are in registration. Management’s goal is to have 15 – 20 submissions in 2010 – 2012. Whether any blockbuster drugs emerge is, of course, uncertain. But investors have no expectations anyway, leaving plenty of room for positive surprises.
4. Newer drugs already on board are doing well, and posted robust sales in this year’s first quarter: Lyrica (fibromyalgia) - $582 million, up 47%, Sutent (cancer) - $190 million, up 86%, Chantix (smoking cessation) - $277 million, up 71%.
5. Management is streamlining the company. Costs are targeted to drop by $1.5 - $2.0 billion by the end of 2008, as compared to 2006.
6. Pfizer is a cheap stock. The shares failed only 2 of the 12 Company Stock Risk Profile valuation measures. Pfizer offers a dividend with a juicy 6% yield, which I believe is safe based on the strength of the company’s balance sheet and cash generating capability.

Investors with the fortitude to take the road less traveled should consider Pfizer. Whether Pfizer delivers a positive surprise down the road is anyone’s guess. But if the company should, the stock would be a rewarding investment indeed. In the mean time, you’re getting paid a very attractive dividend and own a stock that I believe has minimal downside risk.

Disclosure: none

Comments

[bilo5705:]

I like your thinking. The yield is phenomenal and secure with minimal downside at these levels. There has been much clamoring by Wall St. commentators that PFE needs to make an acquisition to boost the pipeline. The CEO's last appearance on CNBC was less than inspiring as he seemed to play questions about that possibility very close to the vest.

I'm perfectly happy to park some cash in PFE and collect that juicy div while patiently waiting for some good news. It is my sense that these shares are a coiled spring, just looking for a reason to pop.

2008 May 19 08:54 AM

[eap727:]

Collect the dividend AND sell calls to juice the return. There's at least another .40 in the Dec. $22.50 '08's. So what if you get called away. You're return is very attractive, and it gives you some downside protection. Also, it's very likely that the stock will be flat until the pipeline starts to show something, which may take you out to 2009. If so, roll the calls and take in more premium.

2008 May 19 10:28 AM

[Steve Alexa...:]

Excellent analysis on PFE. Downside is pretty limited. Collecting the dividend allows PFE to trade with the market and still beat it by 6.5%. Not to mention that this is the cheapest the company has been since the 90's. One of the best performing stocks of the 20th century and in business for 160 years. Good long term play today.

Steve
magicdiligence.com

2008 May 19 10:58 AM

[TA:]

I've liked Pfizer for years - it's definitely the kind of situation and stock I prefer. Your well thought out analysis only confirm it.

Unfortunately it happens to be in the healthcare industry which I refuse to buy into because companies are always one FDA or major lawsuit away from a 10-20% single day drop in their stock price(MRK lately anyone?).

2008 May 19 12:30 PM

[2centsonly:]

Why doesn't a company like this just buy a generic producer and then continue selling product after patent expiration? Teva seems to be doing OK.

2008 May 19 01:08 PM

[ajhough:]

I like the discussion of PFE. I still own a good deal of this stock and have watched it grow as value investment from a growth. I think it is a pretty good gamble that it will eventually become a more solid investment and you are getting paid to wait.

2008 May 19 03:45 PM

[bryanz:]

PFE does seem like a good potential candidate for a covered call strategy.

$128 annual in divs per 100 shares + ~$45 per call option on those Dec 22.50s (minus expenses of course). 100sh PFE costs $2025, figure $64 in divs for the rest of the year + $45 for the call...
$110/2025 = 5.4% gain in 6 months or almost 11% annualized, which would hopefully neutralize any further downside in PFE.

My concern is that the P/E is still relatively high for a really large company with flat/declining revenue.

2008 May 19 05:35 PM

[Football Geek:]

It's the nature of the business that Drug companies are out of favor.
They spend millions / billions on the pipeline to bring these drugs to
market. They get no credit for all the good they do, and people they cure.

I have owned the stock since 2004, so my downside is not as great as investors who have bought PFE thru the 1990's.

I'm not so sure that Lipator will be so out of favor. Most people who are sick want the best, and it's the market leader.

2008 May 19 11:02 PM

[User 183475:]

They did buy a generic producer called Greenstone approximately 4 years ago where they produce generic gabapentin.


On May 19 01:08 PM 2centsonly wrote:

> Why doesn't a company like this just buy a generic producer and then
> continue selling product after patent expiration? Teva seems to be
> doing OK.

2008 May 20 08:45 AM

[Norman Lepo...:]

I agree with all of you. PFE is a good buy at this level.

2008 May 20 10:53 AM

[Golden Oxen:]

An over 6% yield on a company of this quality is absurd. It is also a great hedge against a dollar decline which no one seems to have mentioned. What a stock to put away for a kid in a DRIP for college money.

2008 May 20 11:30 PM

[Derek Syphrett:]

PFIZER IS NOT A GREAT BUY. DON'T BUY DRUG STOCKS FOR DIVIDEND YIELDS... THAT'S A MIS-MATCH OF INVESTMENT STYLES.

Drug Stocks trade on drug pipelines. Buying them for dividends is asking for trouble.

While I tend to agree that the best time to buy a pharma stock is when the cubbard is empty. I wouldn't chase after Pfizer for three reasons.

1. Pfizer has shown a distinct inability to discover novel drugs or even acquire well over the past 10 years.

2.It's such a large cap that Pfizer will many new drugs to move the needle at this point and drug development is only getting harder... there are many great drugs coming off patent and the next blockbuster need to be substantially better to out-earn them.

3. In an election year where national healthcare is a campaign issue you could be asking for more trouble than you can know.

To summarize my point I'd say:

There are easier ways to make a lot more money a lot sooner than buying a under-managed pharmaceutical company facing monumental secular and competitive challenges

I used to work at Pfizer and I thoroughly enjoyed my time there but that doesn't change the fact that Pfizer hasn't developed a blockbuster drug "on purpose" in about 10 years... remember Viagra was a lucky mistake that failed it's first indication.

2008 May 21 12:52 AM

[DaveinHacke...:]

Pfizer seemed cheap when I tripled my position in it last year at $24.95. And then it got cheaper (amazing how that happens). Still reinvesting the dividends though. With that pile of cash, Pfizer ought to be able to acquire some innovative new drug candidates even if it has trouble coming up with them in-house. Maybe something positive will come out of its new biotech R&D initiative.

2008 May 21 02:15 AM

[didcrywolf:]

First of all, I own the stock but do not necessarily recommend it!
Pfizer needs to rework its organization. There was an interesting article in the Harvard Business review last month that suggest big pharma needs to separate best of breed vs. first to show into separate organizations. Pfizer isn't really excelling at either today.
Tomorrow
Of those 102 medecines in the pipeline which are which?
Of the successful ones, how much money will they need to generate just to cover the coming off patents?
How many have a market for $3BB/yr?
PUNDITRY
I believe with such a big cash hoard, the company could reinvent itself and take advantage of much more promising areas in best of breed than waste time in US litigation laden high risk and poor reward scenarios for new products...
In conclusion, stock is at 10 year low because market realizes that what was once low picking fruit and easier to solve medical issues, is now a much tougher market with patent expiry coming ever faster and you need to beat people at their own game otherwise generics will have you for lunch. Now if they insist on spending investor money, they should look at the Monsanto play book for a clue on how to run a successful organization in the 21st century.

2008 May 21 08:40 AM

[Crookedwood:]

The future is not found in the past nor is it discovered in the present moment, but faith in the future is reflected in the action of the moment and the full benefit of the future will come with action now. Pfizer is a strong buy below twenty.

2008 May 21 09:28 AM

[Just Say Whoa!:]

"It's the nature of the business that Drug companies are out of favor. They spend millions / billions on the pipeline to bring these drugs to market. They get no credit for all the good they do, and people they cure."

That's true. But Drug companies actually spend MORE on marketing, than they do on drug research.

STRIKE ONE!

Plus, Drug companies quite often bring out "copycat" drugs with little or no additional benefits to existing drugs, just to capture new market share, but provide no new drug relief.

STRIKE TWO!!!

Then, on top of all that, Drug companies commision several studies on the efficacy of their drugs, throw out the ones that show their new drugs are less useful than a 5cent placebo and rig the ones they do use by paying "independent" (yeah, right) companies to test their drugs.

STRIKE THREE!!!

2008 May 21 12:26 PM

[BioInvestor:]

special1person: I don't really see the point of the comments. They're not useful in that they either lack relevance, veracity or both!

If companies spend money on marketing, so what? What's the issue with that activity? Marketing isn't bad.

I have no idea where the comment on "me too" drugs come from. FDA has requirements when it comes to efficacy. Drug companies just don't decide what drugs to launch. A drug with no discernable benefit over other treatments will have a challenge getting approval. Even in a given market, no two drugs are identical--different people respond to a given drug in different ways. I don't see any issue with "me too" drugs.

The third comment is deceptive--perhaps naive! Some companies do commission referreed articles directly or, increasingly, through a third party, and use such articles as a communication vehicle with physicians. Your statement is erroneous in that there is an inference that this process occurs during the clinical trial process: it does not.

2008 May 27 05:05 PM