Pfizer (PFE)

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 4 quarters, so it can pay the dividend out of cash it is generating - but that consumes most of its cash flow.

There have been rumors that the dividend may be cut or decreased this year or in the near future, especially after the expiration of Lipitor.

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 US 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 their balance sheet is really available to be used as desired, for example to pay out the dividend if necesary?

Pfizer has always been a divident aristocrat, increasing its dividend an average of 17.7 % annually for 10 years, ^[1] - above the growth in the company's earnings per share. This translates into dividends doubling roughly every 4 to 5 years. But today, with major drugs coming off patent in the next several years, it's uncertain where the revenue to support this dividend is going to come from.

Looking at Pfizer in its current position, the picture isn't that pretty. Of the company's 2006 revenues of $48 billion, its blockbuster cholesterol drug Lipitor was responsible for $12.9 billion. That's all well and good, but Lipitor isn't going to be around forever. Pfizer’s key drug, cholesterol drug Lipitor, which accounted for about a quarter of Pfizer’s sales over the last 4 quarters and 65% of its cash flow according to Credit Suisse Pharmaceuticals analyst Catherine Arnold, goes off patent protection in 2010. That’s a huge worry.

With a patent expiration coming as soon as 2010, Lipitor (and it's 26% contribution to Pfizer's revenue) are going to be opened up to a wide range of new competitors, many of whom will be more than glad to cut prices down to a fraction of the drug's current level. And the chances that any of the drugs in Pfizer's development pipeline will come close to matching Lipitor's dizzyingly high sales are pretty slim. The most promising of Pfizer's candidates was torcetrapib, the first of a new class of heart drugs known as CEPT inhibitors. Torcetrapib showed promise in not only lowering "bad" cholesterol but increasing "good" cholesterol, which is widely viewed as the next step in the pharmaceutical treatment of cardiac disease. Pfizer sunk $800 million into developing torcetrapib and moving it to market as quickly as possible, aiming for a 2009 release. But the drug was scrapped in late 2006 when late-stage clinical trials showed substantially increased mortality rates among subjects who had taken it in combination with Lipitor. Now Pfizer's $800 million and one potential blockbuster down, and the clock is ticking until the Lipitor cash cow heads off to slaughter. Unless it can somehow discover, develop, test, and gain approval for a new wonder drug (a process that can easily take over a decade) in the next three years, Pfizer can expect both revenues and earnings to suffer.

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 seem like Pfizer will be able to maintain current levels of revenues, earnings and cash flow once Lipitor goes off patent protection in 2 years.

Pfizer stock has stayed consistently to the high teens, unprecedented for the pharmaceutical giant in the past decade. In addition to the upcoming expiration of Lipitor, safety issues with near-term pipeline products such as Chantix, Sutent, and Lyrica has brought down expectations for future earnings. Pfizer has plenty of cash on hand, but it must make wise choices in its acquisitions to pull out of this slump.

Drug development is costly and its success is inherently risky, a fact well-demonstrated by the recent failure of Torcetrapib. Another candidate drug failing a late stage clinical trail would have significant financial consequences for the company.