Is Pfizer's 7% Dividend Safe?

 

The dividend is really important to me.  The company feels they can keep it up through the patent expirations, but it seems like it’s going to be difficult.

- Kent Croft, President, Croft Leominster

 

There’s been a lot of talk and action regarding Pfizer (PFE) since an article (subscription required) in last Tuesday's Wall Street Journal questioned whether it might have to cut its attractive 7% dividend.

Last Thursday, Goldman Sachs (GS) cut Pfizer from Buy to Hold and removed it from its Americas Conviction List (“Two To Watch In Big Pharma” (subscription required)). 

As a result, the stock is down more than 11% in just the last three weeks (PFE YTD Chart).

While there are a lot of legitimate concerns regarding Pfizer’s business and stock, I think the stock is starting to look attractive at these levels.

Let’s start with the legitimate concerns:

 

• First off, the dividend consumes most of Pfizer’s cash flow.  It will cost Pfizer about $8.7 billion this year to pay its $1.28 annual dividend on its 6.76 billion outstanding shares.  Pfizer generated $13.3 billion in free cash flow over the last four quarters, so it can pay the dividend out of cash it is generating - but that consumes most of its cash flow.
• Second, while Pfizer has a ton of money on its balance sheet ($28.6 billion in cash and short term investments as of March 31, 2008), a lot of this cash is held outside of the U.S. and would require repatriating which would result in taxes in order to be used to pay the dividend.  So this is a worrisome issue.  How much of that cash on its balance sheet is really available to be used as desired, for example to pay out the dividend if necesary?
• Third, Pfizer’s key drug, cholesterol drug Lipitor, which accounted for about a quarter of Pfizer’s sales over the last four quarters and, according to Credit Suisse Parmaceuticals analyst, Catherine Arnold, 65% of its cash flow goes off patent protection in 2010.  That’s a huge worry.
• Finally, Pfizer’s pipeline and current portfolio doesn’t seem to have any blockbusters that can make up the shortfall when Lipitor goes off patent protection.  In other words, it doesn’t look like Pfizer will be able to maintain current levels of revenues, earnings and cash flow once Lipitor goes off patent protection in two years.

These are some pretty significant and legitimate concerns.

On the other hand, the valuation is starting to become compelling.  Pfizer has about $16 billion in net cash and investments on its balance sheet (once you back out the debt).  It is now trading for about 11 times enterprise value (market cap - net debt) last four quarters net income and 8 times last four quarters cash flow.  That’s cheap. 

The 7% dividend is probably sustainable for at least the next two years and so that is also an incentive to hold, at least for a while.  Even if Lipitor generates half of Pfizer’s cash flow and that gets cut in half in 2010, 2011, we’re still looking at a 10 times multiple on free cash flow, and that is still cheap.

I’m not going to lie: I’m a little scared to be holding Pfizer here, but sometimes that’s a sign of a good investment.

Disclosure: Top Gun is long Pfizer shares.

Comments

[redbaron:]

If you are trying to buy income, why not buy into some of the Canadian Royalty Trusts, such as Canadian Oil Sands Trust, which has 70 years of production without a projected decline and is paying out about 10%. Seems much safer to me. Other candiates would be PWE, or some here in the US, such as HGT. All are paying at least 10%, and have long life projections. They suer look safer to me. IMHO

2008 Jun 12 08:35 AM

[Riley:]

The only problem with this is new Taxes coming in 2011 for US. citizens

2008 Jun 12 10:18 AM

[Greg Feirman1:]

We owned just those Canadian Oil Sands Trusts you mentioned (CNQ, PWE) for quite a while. But with an economic slowdown/recession looming and oil in what I think is a bubble, I actually see a lot of risk in those shares. I sold them way too early (early '07) but I wouldn't buy them here. CNQ especially has had a wicked run the last few months. I think it has a lot of air to come out if oil cracks.

2008 Jun 12 07:38 PM

[distinguish...:]

I thought your article was clearly written. Does the author ever return comment on these commentaries by the readers?

2008 Jun 13 11:25 AM