At $16, Pfizer stock is discounted 39% from the estimated value of $26 using discounted cash flow analysis. The valuation is starting to become compelling. Pfizer has about $16 billion in net cash and investments on its balance sheet (once you back out the debt). It is now trading for about 11 times enterprise value (market cap - net debt) last 4 quarters net income and 8 times last 4 quarters cash flow. That’s cheap.
The 7% dividend is probably sustainable for at least the next 2 years and so that is also an incentive to hold, at least for a while. Even if Lipitor generates half of Pfizer’s cash flow and that gets cut in half in 2010, 2011, we’re still looking at a 10 times multiple on free cash flow - still cheap.
The PFE problem is that until science does deliver, the necessary catalyst is lacking. And after 10 years, repair is going to take time. My view is that there is a strong case for major pharma, even if science is slow in delivery. The valuations and yield is great; and the growth potential enormous - the twin intangibles R&D & supply chain (marketing) can and will deliver. It is not a matter of if; its a matter of when. There are few areas where growth potential is huge and at the same time valuations compelling. Big pharma in general and Pfizer in particular is one such area.
Ultimately it comes down to considering whether a non research based pharma (generic) can survive. As time goes by, the marketing machine of big pharma will be an important asset for big pharma together with R&D.
Generic sellers will end up being low cost contract manufacturers for major pharma. If PFE decides to compete once Lipitor goes generic they can; with their marketing the Ranbaxy's of the world will not stand a chance unless they work with big pharma on the contract manufacture side. Generics manufacturers have nothing by way of an entry barrier and they cannot compete on sheer resource & scale. Even on the product, the correct cocktail is better than only the active ingredient; so one could argue that PFE will make the best "generic" Lipitor!
As far as the growth potential in pharma; I was born immortal and so shall I die; at birth I drew my first breath on a genetic memory; my heart beat of its own accord and my brain operated a highly complex organism without instruction. As I die, my genetic legacy shall live on. Humans have such a desire to live in perpetuity, be it through life extensions or reincarnations; that an industry which tries to satisfy the human quest for immortality must succeed. That aside, I have always wondered whether an answer to the age old Indian epics lies in Bio-tech; as in is immortality or reincarnation simply a genetic legacy explained; did Rama truly live for an epoch through advanced medicine or is it simply living through passage of a genetic legacy (with death being the consequence of the maternal line being ultimately extinguished); or hybrid beings (mythological beings like Garuda) a genetic possibility. There is so little we know and so much to accidentally discover; health-care remains a huge growth area. And Pfizer as a R&D focused organization has amongst the best chances of making that accidental discovery. Patience and a yield makes it worth the risk & the wait.
The growth opportunities in the pharmaceutical industry lie outside US; that is where the human quest for immortality is at its earliest stage.
Pfizers immediate problems are:
(a) Science - Pfizer needs to move away from synthetics and into biologic, genetic, stem cell solutions; unlike synthetics, these latter areas are less prone to patent disputes. They can build this pipeline in house, in-license it or acquire it. More than a pipeline, I feel a high quality of earnings pipeline is what is required. Success from their existing pipeline will provide a catalyst to a higher multiple, but long term, refocus on quality of earnings needs to be a priority. Synthetics is yesterdays game and it would be a shame to see Pfizer fall by the wayside because the failed to glimpse the future; much like the US Auto majors.
(b) Marketing - this is a big strength and it must be leveraged. With drug approvals taking so long, the time in market from patent filing is far lower than before so making the most of the market is critical. Using this intangible to compete with generics might be interesting.
(c) Financial - there is limit to how much US leverage can be used for share buy backs & dividends. There is a high cash build from overseas operations and ultimately the foreign cash needs to come back to US and this will come at a tax cost. Since this cash is "trapped" outside US, perhaps use in an acquisition of non US assets would be viable. I do feel use of a debased currency such as Pfizer's shares or the $ is a deterrent in planning an acquisition, but perhaps a stronger $ will help. If this occurs, a reverse acquisition which inverts the group should be considered. For now, I love the way they are using cash to in license drugs; this reduces both cost and risk; together with significant investment in R&D this will deliver growth. The in licensing process is a very VC/PE investor format except that instead of acquiring an entity, what is being acquired is the entities future cash flows; since Pfizer has the domain expertise chances of successful delivery of value is high.
d) Management - A visionary CEO supported by a strong General Counsel please. Patents need to be protected, but legal is a support service, not the core business. Overall, I believe management are headed in the right direction; but it is more of a drift than a purposeful stride. This needs to change. UPDATE: Of late Pfizer's phase III pipeline targets for 2009 have been achieved a year early; cost cuts are working; entry into generic space has been announced; I also like the commitment to newer science (biologic and stem cells) and move away from statins very much. Management now sounds more confident. A reinvigorated management is a very strong sign of a successful turnaround commencing.
Until science delivers there is no great catalyst. Absent a catalyst, I would look for a range of $14 to $25. A catalyst emerging would drive re-rating & multiple expansion. For now, the only catalyst is the pharmaceutical industry defensive characteristics, which together with the dividend should mean the stock should find near term support and trade upwards to $25-$30 range (including dividends).
Pfizer's in a good spot. Its Lipitor is the number one pharmaceutical currently on the market, raking in over $12.9 billion in 2006. Lipitor's patent is good through 2010, giving Pfizer both the time and the money to develop its next blockbuster from the 42 products it has in Phase II clinical trials or later. As a pharmaceutical powerhouse, Pfizer has one of the highest profit margins in the industry, with 2006 margins of 22.82%, compared to Merck at 19.59%, Sanofi-Aventis at 14.28%, and AstraZeneca at 16.9%. While generics and political pressure could pose some risks to Pfizer's continued success, the company has a large enough bank account to effectively ward off these threats. Even though Lipitor won't always be there to pump cash into the Pfizer coffer, a number of the drugs in its pipeline are showing particular promise, such as the surprisingly well-selling pain medicine Lyrica, currently being tested as a treatment for fibromyalgia, and the HIV drug Maraviroc, which is on the fast track to approval. With a current P/E ratio of 9.89 times earnings (the lowest of any of its competitors for the last 12 months), there could be significant upside to Pfizer's stock price when these drugs hits the market.
PFE has 213 products in the research pipeline, atleast one of them is bound to be the next Lipitor. Probability of success is high. With stock price falling consistently, this is the right time to buy.
I like this pharmaceutical play – one of the better values among the big pharma. While the upside is relatively limited over the next year, so is the downside. In the meantime, the 7+% dividend is reasonably safe and very attractive. Nice pipeline of new drugs should help maintain profits going forward. Licensed generics route may give a new life and revenue source to the expiring blockbusters.