Pfizer Earnings Preview: All About Capital Allocation, And Hope For The Pipeline

Oct.29.12 | About: Pfizer Inc. (PFE)

Pfizer (NYSE:PFE) the large-cap pharmaceutical giant, reports its 3rd quarter financial results before the opening bell Tuesday morning. Analyst consensus is looking for $0.53 in earnings per share (versus $0.62 for the year-ago quarter) on $14.6 billion in revenue (versus $17.2 billion in revenue in the year-ago quarter) for year-over-year (y/y) declines of 15% and 15% respectively. (Some of the year-over-year weakness might be due to analysts excluding the Nutrition business of Pfizer's which has been sold to Nestle (OTCPK:NSRGY) for $12 billion.)

Lipitor coming off patent in the US in late 2011 and now Europe in 2012 has just decimated any growth prospects for PFE, but remarkably, despite this financial shock (which everyone knew was coming) the stock is up over 17% this year, which doesn't include the $0.88 or 3.5% dividend yield at the current stock price.

Lipitor sales are expected to fall 50% this year from $9.5 to roughly $4.5 billion, which was almost 20% of PFE's total revenues last year. Pfizer management has offset this top-line pressure by generating cost savings through expense reductions, share repurchases and better capital allocation, and better prospects for the current pipeline. (Lipitor revenues fell 42% y/y in Q1 '12, and 53% in Q2 '12.)

The sale of Pfizer's Nutrition business was a lower margin business than the other segments thus some of the M&A activity PFE is engaged in, is helping drive better margins.

A research note out of BMO Capital Markets in mid-October, 2012 noted that BMO thinks that Pfizer management is bent on improving the overall operating margin from 40% to 43% (which BMO thinks is doable).

Looking at the consensus earnings estimates for PFE for 2012 through 2016, there isn't much in the way of growth expected, since the estimates range from $2.21 in 2012, to $2.66 in 2016, which is a total of 20% cumulative growth over 4 years, or roughly 5% per year. Consensus revenue estimate are expected to be flat to down over the same time frame, as the attached table reflects:

2016 $2.66 $58.08 bl
2015 $2.53 $57.46 bl
2014 $2.43 $57.88 bl
2013 $2.33 $58.56 bl
2012 $2.21 $59.47 bl
Click to enlarge

The key to Pfizer's progress in terms of stock price performance seems to be capital allocation: PFE generates $15 to $20 billion in annual cash-flow, of which $12 - $15 billion is free-cash-flow. At its current $0.88 per share annual dividend per share, the total dividend amounts to $6.6 billion annually, with the rest of free-cash partially going to share repurchases.

Since 12/31/10, to 3/31/11 or in 5 quarters, or 15 months, Pfizer reduced its outstanding share count from 8.0 to 7.5 billion and reduced its long-term debt by $8 billion.

The Zoetis spin-off, which is another plus, is expected to generate $8 billion in additional capital, most of which is already modeled for share repurchases, and is scheduled for early 2014.

You'll notice how so far we haven't even talked about Pfizer's drug pipeline, which has been almost forgotten and for a while was valued at little or nothing. I thought Pfizer's stock might get whacked in early September when the company announced the failure of their Alzheimer's drug Bapineuzumab, and pretty much said any hope for any future Alzheimer's drug trial has been shelved, but instead the stock is up another $1.50 since that time.

Pfizer has chosen to focus on its core pharmaceutical business and with the spinoff or divestiture of the ancillary businesses, much of that capital will go to paying down debt, share repurchases, and more dividends, even though Pfizer is already generating a decent amount of free-cash-flow. While the dividend could get increased, my guess is that management might choose to have more flexibility with the share repo or debt pay-down.

The next major catalyst for PFE would likely be FDA approval of some of its Stage III drugs that are still in the pipeline. The stock has been a steady, stable consistent performer in both good and bad markets, but I wonder if the "capital allocation" and cost savings bid is fully discounted in the stock.

We have been buying Pfizer on pullbacks although they don't occur very often. We think the Pfizer and large-cap pharma trade could continue to work for a while for longer-term investors, based on low expectations, intelligent capital allocation and what could be surprising pipeline successes.

Pfizer is still just trading at half its April 1999 peak of $49.99 per share, and it is a far better value today.

Disclosure: I am long PFE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.