Expert Financial Analysis and Reporting

Pfizer is entering a patent cliff period in which sales will decline over the next two years. The drug pipleline is modestly promising but not so much so that it can significantly accelerate the giant sales base of the company in ensuing years. The current dividend yield of 4.1% and a strong cash flow that may be used to buy back shares makes it modestly attractive to value investors.

Pfizer- A Cheap Lumbering Stock

The acquisitions of Pharmacia, Warner-Lambert and Wyeth have made Pfizer a large lumbering giant that is very difficult to analyze. In 2010, it had sales of $67.8 billion of which $58.5 billion or 87% came from biopharmaceuticals. On a geographic basis 43% of sales were in the US; 25% in Western Europe and Scandinavia; 15% in Australia, Canada, New Zealand and Japan; and 18% in Russia, Turkey, Asia (other than Japan and South Korea), Latin America, Middle East, Africa, Central Europe and Eastern Europe. Pfizer has 15 products that have sales of over $1 billion. Its largest products in 2010 were Lipitor, $10.7 billion; Enbrel (outside the US and Canada), $3.3 billion; Lyrica, $3.1 billion; Prevnar/Prevenar 13, $2.4 billion; Celebrex, $2.4 million; and Viagra, $1.9 million.

This level of complexity makes projections exceedingly difficult given the diversity of products and operating theaters. Hence, most Wall Street analysts and investors lean heavily on financial guidance provided by the company and balance sheet and cash flow analysis in forming investment opinions.

The single largest product issue facing the company is the expiration of patent protection on Lipitor (18% of worldwide biopharmaceutical sales). The patents have expired or are beginning to expire throughout the world; generic competition to Lipitor in the US in which it has $5.3 billion of sales will begin toward the end of 2011. We project that Lipitor sales in the US will decrease to about $5 billion in 2011 and then fall off the cliff to $500 million in 2012. We think that Lipitor worldwide sales will decrease from $10.7 billion in 2010 to $1.0 billion in 2015.

Investors are relying on guidance from Pfizer to judge how the company will withstand the precipitous decline in Lipitor sales, especially in 2012, the year in which US sales will be hit hard. On its most recent conference call, Pfizer issued the following guidance for 2011 and 2012.

• In 2010, Pfizer had worldwide sales of $67.8 billion. It expects worldwide sales of $66.0 to $68.0 billion in 2011 and $63.0 to $65.5 billion in 2012.
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• Through reducing spending on selling, informational and administrative expenses and R&D and through holding the tax rate flat, it believes that it can hold adjusted diluted EPS roughly flat.
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• Adjusted diluted EPS take Generally Accepted Accounting Principles (GAAP) earnings and adjust them for purchase accounting charges, acquisition related costs, discontinued operations and other non-operating items. Investors focus on these adjusted EPS in judging earnings growth and calculating P/E ratios. Reported adjusted, diluted EPS were $2.23 in 2010. In 2011 they are projected to be $2.16 to $2.20 and in 2012 may come in at $2.25 to $2.35.
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There are some credible bulls on Pfizer who argue that the stock is cheap selling at about 8.7 times 2011 adjusted EPS and 8.4 times 2012 and also point out that it has a dividend yield of 4.1%. It has a very strong balance sheet with $21 billion of cash. Its free cash flow for the next two years should be about $8 billion which would allow it to buy back 5% of shares outstanding in each year. Alternatively, it could use the cash for acquisitions. Both could enhance shareholder value.

I think that Pfizer at this price and with the investment characteristics just cited has little downside risk but not that much upside. Its current product line has very modest growth potential so that new product successes will be necessary to increase sales and given the huge sales base, it takes a very large new product to move sales meaningfully. I am focused on three products that could have such potential, perhaps individually but more likely in the aggregate to drive sales growth:

1. Tasocitinib is an oral, mixed JAK-1/JAK-3 antagonist that is being developed for rheumatoid arthritis, but might also be useful in psoriasis, asthma, Chrohn’s disease and transplant rejection. The issue with this product is the therapeutic window or the balance of efficacy (which is very good) against some troublesome side effects that are mechanism related. This, in my judgment, is Pfizer’s best hope for a blockbuster and could be a multi-billion product.
2. Apixiban is an orally active Factor Xa inhibitor that is being developed in collaboration with Bristol-Myers. It is being studied in a comprehensive phase III program for the prevention of venous thromboembolism, stroke prevention stemming from atrial fibrillation, venous thromboembolism treatment and acute coronary syndrome. It also has multi-billion sales potential, but the economics are shared with Bristol-Myers.
3. Bapineuzumab is the wild card in the new product lineup. It is a novel monoclonal antibody specific to beta amyloid that represents a new way of treating mild to moderate Alzheimers' disease. Data reported so far has been unclear as to its ultimate utility and it is still not clear if the build up of beta-amyloid is causative of, contributory to or just the result of Alzheimer’s disease. Phase III data due in 2012 should give a more definitive insight into its potential.
4. There are a large number of other drugs of lesser potential in the pipeline such as axitinib for renal cell carcinoma and bosutinib for chronic myelogenous leukemia that appear to have more modest albeit meaningful sales potential.

The company’s strategy appears to be to move forward with its current in-line and pipeline products augmented by company acquisitions like the recent King Pharmaceuticals deal or just outright acquisitions of products. Modeling all of this is difficult and imprecise, but I think that it could lead to growth in sales and adjusted EPS of perhaps 2% to 6% over the 2013 to 2018 time period, depending on the success of new products. This would be competitive with the S&P 500 and given that the S&P 500 is selling at a much higher multiple, there is room for multiple expansion. Just moving to a P/E of 12 in the next three years or so could result in a 50% increase in stock. I wouldn’t argue strongly against someone buying the stock at the current time.

Still, Pfizer is not for my portfolio, at least not right now. I see no rush to buy the stock until later, perhaps in late 2011 or 2012 or even 2013 when we get more insight into the product characteristics of the key new products and the Lipitor sales decline will be in the rear view mirror. I think that success of new products is needed to move the stock meaningfully. New product progression toward commercial launch and success has become extremely unpredictable. The clinical profiles of the three key new drugs are not so well established as to rule out the emergence of a crippling effect issue. Also, the FDA is putting great focus on safety and it seems that almost every product receives a complete response letter at the first FDA review requiring at least a half year delay and sometimes years. And finally, the reimbursement process is painful for a new product so that much of the first year is spent in gaining reimbursement with limited sales. There is significant risk that one or more of the three key new products could disappoint because of one or more of these factors.

There is one scenario that would cause me to go to a buy right now. I would like to see Pfizer decide to form a number of smaller, more mobile companies with highly motivated management teams out of its huge and hard to manage sales base. If these were then partially or entirely spun-off to shareholders, it could create a lot of shareholder value very quickly, in my opinion. However, I don’t see the newly in place management team doing this just now. The company is investigating selling off its nutritional and Capsugel businesses that could raise $8 billion or so, but these are non-core businesses and this should not to be confused with splitting up the biopharmaceutical business.