Despite the latest setback in clinical trials for Pfizer's (PFE) closely monitored Alzheimer's drug, and the loss of its drug Lipitor's exclusivity, we maintain that the company has solid financials and long-term strategic planning. The company has embarked on cost reduction and productivity initiatives, which bode well for its post-Lipitor future. In light of the new strategic focus, explained at length below, we recommend the stock as a buy.
Pfizer's Q2 2012 EPS came in at 62 cents, well ahead of the consensus estimate of 54 cents. Revenue and margin performance were commendable in light of the recent exclusivity loss of its blockbuster drug, Lipitor, as well as other drugs such as Caduet, Xalatan, and Geodon. Strong volume growth in China and Russia contributed to the 14% quarter-over-quarter operational growth in emerging markets.
Pfizer's new initiatives seek to focus on the company's strength by prioritizing areas that have the greatest scientific and commercial potential. This will involve acquisitions (e.g., Wyeth in 2009) that result in synergies and cost reductions across the company. Part of the rationale behind Pfizer's acquisition of Wyeth Pharmaceuticals in 2009 was to counter the pressure to be expected on revenues once competition from generic drugs builds following Lipitor's patent expiration. What made the deal particularly lucrative for Pfizer was Wyeth's production of biologic drugs, such as Prevnar, a vaccine that prevents pneumonia and meningitis, which are less prone to generic brand competition. Another high-profile acquisition by Pfizer of King Pharmaceutical in 2010 strengthened the company's existing product line of pain drugs.
Furthermore, to achieve its objectives, Pfizer has shut down duplicative facilities, including manufacturing plants, sales offices, and research and development facilities. Traditionally, companies screened innumerable compounds to find those most suited to their needs, which involved heavy spending on labs and on other tools for research in the hopes of discovering the next blockbuster drug. Disappointingly, results for Pfizer were not concomitant with the amount of injected capital. For example, the only major drug churned out of Pfizer's largest research center in the world in the last 20 years was Chantix. Research failures have impacted Pfizer since 2006, beginning with the cholesterol-reducing drug, Trocetrapib. Recently, its closely watched Alzheimer's drug failed in its clinical trials.
Pfizer, in light of these developments, has initiated plans tha reduce its R&D footprint and the number of disease areas it is focused on. Part of the plan is increasing collaboration with universities, while embedding operations in the same buildings where renowned universities house their research labs. This offers academic researchers extraordinary resources for drug development. The driving force behind these measures is to increase productivity across the board by reinventing the model around which Pfizer generates and builds its ideas.
Although the company does not have a drug that will substitute Lipitor's sales (which accounted for 14$, or $9.6 billion, of total sales in 2011), Pfizer has been trying to fill the gap with new medicines. Three such drugs are in the late stages of the development process. The table below shows the patents next in line for expiration.
Source: Pfizer's 10-K.
Next in line, with regard to Pfizer's strategy to become a more focused organization, is the sale of its nutrition business to Nestle (NESN) for $11.9 billion, and another one for a 20% minority stake in the Animal Health Division, for which a full separation may be sought by 2013. Pfizer has already repurchased $66.1 billion worth of shares since 1998, and it plans on using the funds from the recent unit sales for an additional repurchase of $5 billion of common stock this year.
Management has expressed its commitment to continually explore alternatives that enhance shareholders' value. We are positive on the aforementioned developments, which seek to bolster the company's core business in terms of shedding off assets that hold more value for shareholders externally.
Pfizer currently boasts a dividend yield of 3.7%, higher than its competitor Johnson & Johnson's (JNJ) 3.5%.
Click to enlarge image.
Within the time frame selected, notice the upward trajectory in dividends. An exception came in 2009, which witnessed the acquisition of Wyeth Pharmaceuticals. Since then, management has increased dividends, which now stand at 22 cents per share.
Ignoring the one-time hike in the payout ratio in 2008, the graph below, which compares the FCF yield and dividend yield since 2006, reveals the sustainability of the dividends.
Source: Bloomberg and Qineqt's calculations.
Pfizer is currently trading at 10 times its forward earnings, against an industry average of 11 times. Provided that cost-cutting practices continue, investors should expect another increase in EPS late this year. Given Pfizer's growth rate and beta, the stock is reasonably valued at its current price of $24.
Source: Yahoo Finance, Thomson Reuters and Qineqt's calculations.
Analyst mean estimates for the price target are $26.34. The current price is just above the most bearish estimate of $22. Given Pfizer's strategic planning, and the strength in its financial position evident from its cash flows, we recommend this dividend paying stock as a buy.
Source: Yahoo Finance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.