Pfizer: Top Dog of the Dow

| About: Pfizer Inc. (PFE)

As I mentioned in a previous blog post, I recently started a position in Pfizer (NYSE:PFE) in my self-directed IRA account. I like to watch the highest yielding stocks in the Dow (the top 10/30 are also known as "the dogs of the Dow") as I like the long-term data supporting this strategy and its simplicity, and think this screen can quickly find quality companies that may be beaten down to levels where they're undervalued and may offer great risk/reward. The current dogs of the Dow are listed below (in order from highest yielding (5.66%) to lowest yielding (3.16%) - thank god Citigroup (NYSE:C) cut its dividend), with my brief thought on each company:

Pfizer (PFE) - Favorite of the group (read on to learn why).
Verizon (NYSE:VZ) - Haven't researched, good company.
AT&T (NYSE:T) - Haven't researched, good company, iPhone.
Altria Group (NYSE:MO) - Late to the party, everyone knows this is THE recession proof play.
General Motors (NYSE:GM) - No thanks to autos, rather look at Ford (NYSE:F) once it's beaten down some more.
Dupont (NYSE:DD) - Haven't researched.
General Electric (NYSE:GE) - Next favorite after PFE, diversified, global exposure, no major worries here.
J.P. Morgan (NYSE:JPM) - Stay away from black box banks.
Merck (NYSE:MRK) - Disappointing Vytorin news, check out the price action to see what the street thinks of it.
Home Depot (NYSE:HD) - Home improvement / consumer exposure...no thanks. At some point will be great value...not yet.

First, let me address the BAD with Pfizer:

  • Naysayers will say PFE has no pipeline and faces major patent expiration challenges, not only over the last few years, but also in the next few years (primarily #1 drug Lipitor due off patent in 2010). In total, this represents about 1/3 of Pfizer's top-line that will need to come from other (unidentified) sources in the future.
  • #1 drug Lipitor is losing market share to generic Zocor (simvastatin). Lipitor represents about 25% of annual revenues for Pfizer (~12 Billion).
  • Recent product failures in Torcetrapib and Exubera cast a negative light.
  • Big Pharma as a whole faces political challenges - Medicare Part D issues and other government programs and proposals could increase the cost of doing business in this industry.
  • New and growing drug, Chantix (smoking cessation drug), recently had some negative press when it had to change the label to state that patients may suffer from suicidal thoughts.
  • As with all drug and biotech companies, there are always unforeseen safety / litigation risks with their drugs and potential pipeline setbacks that could arise (late Phase II or III product failures).
  • Most importantly, the street sees no catalyst on the horizon that could propel the stock higher.

Those are all facts that would probably make you want to go out and sell the stock short as soon as possible. But, let's look at the GOOD:

  • PFE just reported okay 4Q numbers that beat expectations. They raised 2008 guidance and are continuing to focus on reducing costs in 2008 (~$2 billion estimated).
  • In 2007 they repurchased $10 Billion worth of stock. They just announced the authorization of another $5 Billion in 2008. This will help to put in a price floor on the stock.
  • They increased their dividend for the 41st consecutive year, this time by 10% bringing it to $1.28 for 2008, yielding 5.66% as of Friday's (1/25) close.
  • While their domestic revenues fell 8% year over year, internationally revenues increased 15%. Lipitor grew 3% in the US and 13% internationally. Viagra grew 10% domestically and 21% internationally.
  • Pfizer is a very low beta stock, currently down around 0.60. Essentially, this makes it flounder around and move somewhat like a bond or preferred stock. It has lower risk than most common stocks, but still has that dividend and the chance to get "re-valued" by the street at some point in the future (multiple expansion).
  • Pfizer trades at a historically low P/E ratio of 10.3. The industry average is around 16.3 (among companies like Merck (MRK), ScheringPlough (SGP), Glaxo-Smithkline (NYSE:GSK), Johnson & Johnson (NYSE:JNJ), Wyeth (WYE), Bristol-Myers Squibb (NYSE:BMY), Eli Lilly (NYSE:LLY). It is also among the lowest relative valuations on a price to cash flow and price to book basis as well.
  • Pfizer is in the Healthcare sector, THE sector for 2008. Almost every financial advisor out there is recommending an overweight sector allocation to Healthcare. You can bet that many of these sector Funds and sector ETF's hold PFE in the portfolio. Also, many advisors recommend over-weighting large cap stocks as well (better during tough credit conditions), so it is also in the best asset class as well. The recent Dow performance vs. the S&P and Nasdaq over the last several months is proof in the pudding. On top of this, look at Pfizer's price action YTD vs. its competitors. It is down 0.5% on the year, while MRK is down 18%, JNJ 7%, NVS 8%, GSK 7%, SNY 7%, BMY 13%, LLY 5%). Needless to say, it has the relative strength out of the group.
  • 2008 Seems to be the year (at least so far) where growth may finally lose out to value. Look at the momentum names and how bad they've been beaten since the turn of the year. I should know...the majority of the Fund's holdings are in these types of stocks. I'm gradually shifting my strategy towards more of a growth and value approach as opposed to high growth / momentum. Who knows for sure, but it never hurts to buy quality companies at deflated levels.
  • Pfizer has been building what has grown to be a massive balance sheet over the last few years. They have over $20 billion in cash on hand, $5 of which is earmarked for buybacks, and NO DEBT (something very important in this credit environment). To put that in perspective, here is an impressive list of companies under the $20 billion market cap that they could theoretically buy (this is not including the premium the acquirer usually must pay, but they could easily finance part of the acquisition cost as well):

    Amylin Pharmaceuticals (AMLN) - $4.4 billion
    Cephalon (NASDAQ:CEPH)- $4.4 billion
    Barr Pharmaceuticals (BRL) - $5.6 billion
    Forest Labs (NYSE:FRX)- $12 billion
    Biogen Idec (NASDAQ:BIIB)- $17.3 billion
    Genzyme (GENZ)- $19.6 billion
    Allergan (NYSE:AGN)- $19.6 billion
    Celgene (NASDAQ:CELG)- $19.9 billion

    No pipeline? Who cares...they can just go buy one. Of course there are acquisition risks and costs, but to value the stock as if they were never going to grow again? This has been arguably the best pharmaceutical company in the world for many years...the Budweiser of big pharma...the street won't give them any benefit of the doubt?

    They have 3 years to figure out how to replace the sales they will eventually lose as Lipitor comes off patent. With a strong management team and hoards of cash on hand, I don't really see this as huge speculation --- just an unknown that I would give a high probability of working itself out naturally as a quality company pulls through a challenging period in their history. But, Wall Street hates the unknown, so I guess it will trade sideways until the story becomes clearer.

    • The recent Vytorin news. Here's an excerpt from a Zack's report regarding this issue:
      In January 2008 Merck and Schering Plough announced the results of its head-to-head study [ENHANCE] measuring its Vytorin against Zocor [simvastatin] in reducing the risk of cardiovascular events, with the results somewhat surprising. The study, which included 720 patients with Heterozygous Familial Hypercholesterolemia [HeFH], concluded that although Vytorin was more effective than Zocor in reducing LDL cholesterol, it was no more effective in reducing the incidence of heart attack or stroke. This news may or may not bode well for Lipitor, but either way it s clearly negative news for Vytorin. We may see a shift towards generic simvastatin prescriptions and away from the much more expensive Vytorin and Lipitor but it's unclear how much weight this trial data will have on physician and patient opinion and whether Lipitor will benefit from it. At this point we view it as a negative for Merck and Schering but not necessarily good or bad news for Lipitor. We will keep a close eye on whether prescriptions are shifting based on this data.

    I guess I strongly disagree. This is a huge positive for Pfizer's Lipitor. I hear doctors are quickly switching patients off of Vytorin to Lipitor and/or generic simvastatin as well. Lipitor has a ton of supporting data, and is clearly the best statin out there from a clinical perspective. With doubts cast on Vytorin, I can see doctors switching patients to the best of breed Lipitor over the generic Zocor (simvastatin) as an extra precautionary measure --- to what extent is obviously unknown but it is definitely GOOD news for Lipitor.

    However, it is important to note that many health insurance agencies still compensate doctors for switching patients to generics (without disclosure to patients that they are even being compensated! How is that for ethics?), so until that changes Lipitor still faces an uphill battle. Nevertheless, this is good news for Pfizer's Lipitor and I don't feel it has been priced in.

    Summary
    I feel the uncertainties and negatives that exist here are beyond priced in the stock. The market has fully digested Pfizer's weak pipeline and has yet to price in any growth in the stock.

    With a fat dividend, a low beta, a great value (just from the intrinsic value of the future dividend cash flows (which are highly likely...remember 41 yrs straight and highly visible future cash flows, at least through 2010, unlike the scary financial institutions out there) it is slightly undervalued --- this assuming no future growth or increase in the share price which is highly unlikely), sitting in the best sector to own for the foreseeable future...well, you know what I think.

    As far as potential catalysts to propel the stock higher...here are a few:

    1) March 5th: Analyst meeting to discuss long-term growth strategies. Perhaps sparking analyst upgrades or some news regarding other growth avenues.

    2) Acquisition announcements: I think 2008 will be the year of a major acquisition. I wouldn't fathom a guess as to whom, but just getting the ball rolling this year will ensure that by 2010 they will be hitting on all cylinders in time to replace Lipitor in 2010.

    In the meantime, the fat dividend and share buybacks are sure to support the stock near current valuations. When I asked readers what they thought the Dow would return in 2008, the most common answer was around 6%. Well, Pfizer can almost do that on its own with little downside risk and the added bonus of a potential pop on any good news.

    Valuation

    Again, improve the pipeline by an acquisition or prove to the street that the company can keep growing in even a slight way (I'm giving this quality company the benefit of the doubt), and then re-value the stock. At 13X trailing earnings, still a large discount to peers, Pfizer would trade at $28.60, 26.5% from current levels, not including the dividend. It is tough to find that kind of return with less risk these days.

    The Bear Case: Goldman Sachs currently estimates 2011 and 2012 earnings at $2.21 and $2.09 --- at no growth for 5 years and very low P/E of 9X 2011 earnings, price target would be $19.89 --- down 12% from current levels (and again, the dividend and buybacks should support the stock well above this level, especially if they keep increasing their dividend).

    Disclosure: Long PFE common stock in IRA. Looking at call options if the broader market pulls it down further, especially into the March 5th analyst meeting.

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