In previous report Lipitor's expiration: how much will it impact Pfizer's revenue and earnings?, we discussed that Pfizer's (PFE) declining drug sales for key products (e.g. Lipitor) would impact its revenues for 2012. We also discussed how the newly approved drugs would eventually contribute to future revenue growth (Could Tofacitinib Save Pfizer?). In this section, we provide our forecast for Pfizer's financial projection and estimated earnings from 2012 to 2016 (see Table 1, Income Statement and Earnings Projection). Using our projected earnings and free cash flow numbers, we derive an estimated fair value for PFE around $28.
Section 3: Financial projection and stock valuation
The 2011 financial data that we utilized for our analysis was provided by the company in its 2011 annual report (PFE 2011 annual financial review). The data for 2012 was mostly based on our own estimates, except for several items (e.g. Lipitor sales, company 2012 guidance) which the company has provided updated information, disclosed in its Q2 2012 report or via news releases (PFE Q2-2012 earnings report).
Sales and Revenues
Pfizer generated $67.4B sales in 2011. However, Lipitor's patent expiration in 2011 and lost exclusivity of other drugs including Xalatan and Geodon in 2012 will have a significant negative impact on Pfizer's revenues going forward. Although several drugs, including Prevnar and Sutent, have increased sales, they are insufficient to offset the lost revenues from Lipitor. Nor will the recently approved Inlyta and Xalkori make significant contribution to the top line until after 2013: their sales in 2012 are marginal.
Our financial projections estimate that PFE will have a significant reduction in revenue in 2012 compared to 2011. Its 2012 revenues are estimated to be $61.3B, down from $67.4B in 2011. It revenue growth will take until 2015 to restore to its 2011 sales levels of $67B. Its estimated EPS in 2012 is $1.26 compared to $1.27 in 2011.
Based on our revenue projections, PFE's revenue compound annual growth rate (OTCPK:CAGR) is about 3.5%. We will use this growth rate in the stock valuation below.
Expenses and tax
PFE's cost of goods sold (COGS) and selling and general administration (SGA) expenses are about 22% and 29% of net sales, respectively. We used these percentages to derive estimated COGS and SGA expenses.
Pfizer's other expenses include research and development expenses, depreciation and amortization, and restructuring and acquisition related charges. In its 2012 Q2 earnings report, Pfizer expected to incur $800M in U.S. healthcare legislation-related expenses. We estimate that R&D and amortization is about $15B. Total amount is estimated to be an average of $16B for this category for the next 5 years.
PFE's most recent effective tax rate is 29%.
Interest income, debt, and interest expense
Interest expenses were derived from our projected debt and interest schedules. Overall, PFE's long term debt balance will range from $30B to $35B, while short term debts are expected to be $5B. The average interest rate for these debts is approximately 4.8%.
Overall, PFE has a strong balance sheet. Its total debt ratios are 21% and 19 % in 2010 and 2011, respectively. Over the next five years, PFE's total debt should maintain its 20-22% range, unless the company issues new debt for major mergers or acquisitions.
Net income and EPS
Our income statement projects earnings from 2012 to 2016 at $9.4B, $10.0B, $10.8B, $11.6B, and $12.5B respectively (See Table 1, Income Statement and Earnings Projection). With 7,500 million shares currently outstanding and assuming PFE continues to buy back $5B in shares per year, the earnings per share (EPS) will be $1.26 (2012), $1.38 (2013), $1.52 (2014), $1.68 (2015), and $1.87 (2016) (see Table 1).
In its Q2 2012 report, the company provided its earnings guidance for 2012 at $1.23 - $1.38 per share, or adjusted earnings per share of $2.14-$2.24 (PFE Q2-2012 earnings report). Its revenue guidance for 2012 is $58-60B. Our revenue and earnings projections are in line with the company's guidance.
Cash flows from operations (CFO)
Pfizer's cash flow from operations were $16.6B (2009), $11.4B (2010), and $20.2B (2011). Our projected CFOs from 2012 to 2016 are $21B, $14.9B, $15.3B, $16.2B, and $17.2B, respectively. Capital expenditures were $1.5B to $1.8B, representing an average of 11% of CFO. We will use these numbers to calculate free cash flow for the purposes of stock valuation (see below).
Dividends and stock repurchases
PFE increased its quarterly dividend 10%, from $0.20 to $0.22 in Q1-2012, and the dividend growth rate is assumed to be 7% throughout our projected period. Pfizer will pay out a $6.8B dividend in 2012. PFE also issued a stock repurchase program in 2012, and expects to buy back $5 billion of the company's common stock in 2012 and an additional $5B in 2013. However, based on its operating cash flow of $14B-15B, it will be a stretch for Pfizer to continue its 10% dividend increase and share repurchase program. We suspect that Pfizer will maintain the dividend increase, but may need to scale back its share repurchase program.
Summary of financial ratios and growth rates
Based on its previous 3-year averages, PFE's gross profit margin, earnings-before-tax (EBT) margin, and net profit margin are 78%, 48%, and 15% respectively. Its average return on equity (ROE), return on assets (ROA), and return on invested capital (ROIC) are 11.6%, 5.5%, and 25%, respectively. Overall, these ratios suggest that while Pfizer has great operating efficiencies, its profitability based on ROA and ROE is only average.
PFE's debt is about 20% of its capital structure, with an interest coverage ratio of 17x, suggesting that the company is financially sound.
The company had cash, cash equivalents, and short-term investments of $26.7B in 2011. Our projections indicate that the cash/investment balance will increase from $31B to $40B between 2012 and 2016.
Gross profit margin
Operating profit margin
EBT (pretax) margin
Net profit margin
Return on equity (ROE)
Return on assets (ROA)
Return on invested capital
We used three models to derive an intrinsic value for PFE's stock.
(I) Using different P/E multiples, we estimated the stock prices below. With a P/E of 15, the stock's target price is $20 based on 2013 earnings. Pfizer also provided adjusted earnings in which non-cash charges were added back to its reported earnings. If we added back one-time charges including Acquisition-related costs and Loss (income) from operation, estimated to be ~$4B net of tax, then the adjusted EPS for 2013 is about ~$1.92. With a P/E of 15, the stock's target price is $28.8.
(II) Dividend Discount Model
Pfizer's dividend per share for 2012 is $0.91. If we assume a dividend growth rate of 7% per year, we can derive stock values using the dividend discount model with varying required rates of return (R). At 10% rate of return, its current value is $30.
(III) Free Cash Flow (FCF) Discount Model
The FCF discount model utilizes the free cash flows derived from the projected CFO from 2012 to 2016: $21B, $14.9B, $15.3B, $16.2B, and $17.2B. We assumed that capital expenditures are about 11% of CFO. Therefore, the equity values derived from the FCF are shown in the table. PFE's intrinsic value is ~$28, based on a revenue growth rate of 3.5%.
In summary, the P/E multiple method suggests a price target of about $20 (based on estimated 2013 reported) or $28.8 (based on adjusted earnings), with a 15x multiple. The intrinsic values derived from both the dividend discount and free cash flow models are $30 and $28, respectively. At the current price level of $25-26, PFE stock is trading close to its intrinsic value.