Wednesday, August 03, 2011

Pfizer's Still A Sick Corporate Patient

Pharmaceutical giant, Pfizer (NYSE: PFE), reported expectations beating earnings for its second quarter on Tuesday. Is this a buy signal?

Pfizer's sales were down but met expectations while its profit was better than forecast. Specifically, Pfizer's adjusted EPS of $0.60 was a penny higher than the average estimate of 16 analysts surveyed by Bloomberg. Revenue that declined 0.9% matched analysts' estimates of $16.98 billion. And revenues from two of Pfizer's drugs -- the Lyrica pain pill and Enbrel arthritis medicine -- exceeded analyst predictions.

Pfizer is still in the aftermath of a major management shakeup. Former CEO Jeff Kindler was tossed out of Pfizer after a December 2010 meeting with a board committee thanks to a rebellion within the ranks from people who believed he was trying to force too much change on the company and his own difficult management style, according to Fortune.

But the ailments facing big pharma have not gotten any better. Pfizer remains bloated with inefficient R&D, costs that make it unable to compete with generic pharmaceuticals manufacturers who make popular off-patent drugs at much lower costs -- pleasing corporate health plans, and a raft of products coming off patent -- with not enough new patented products to replace them.

Pfizer is taking some action to reduce costs. It's selling its animal health -- its best performing unit in the second quarter (sales up 18%) -- and infant formula businesses -- for as much as $22 billion. And Pfizer is cutting jobs to prepare for the loss of its patent on Lipitor, the $10.7 billion best-selling drug.

It may be able to replace some of this lost revenue. Analysts also think that Pfizer has "three late-stage experimental medicines that analysts estimate may bring in more than $3.5 billion annually by 2015," according to Bloomberg. Unfortunately, nine of the world’s 15 best-selling medicines will go off-patent protection by 2016.

Does Pfizer have what it takes to make investors better off in this competitive environment?

Here are three reasons it might:
  • Expectations-beating earnings reports. Pfizer has beaten analysts’ expectations in all of the last five reporting periods.
  • Out-earning its cost of capital. Pfizer is earning more than its cost of capital – and it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first six months of 2011, Pfizer’s EVA momentum was 3%, based on first six months' 2010 annualized revenue of $67.4 billion, and EVA that rose from $2.1 billion annualizing the first six months of 2010 to $4 billion annualizing the first six months of 2011, using an 8% weighted average cost of capital.
  • High dividend. Pfizer's dividend yield is 4.41%.
There are two reasons to consider avoiding Pfizer:
  • Moderate growth, falling profits and shakier balance sheet. Pfizer has been growing slowly. Its $67.8 billion in revenues have increased at an average rate of 8.8% over the last five years bit its net income of $8.3 billion has fallen at a 6.8% annual rate over that period -- yielding a 12% net profit margin. Its debt has grown quickly but its cash has not changed. Pfizer's debt climbed at 62.6% annual rate from $5.5 billion (2006) to $38.4 billion (2010) while its cash has remained almost constant at $28.4 billion.
  • Extremely high valuation. Pfizer's price to earnings to growth of 12.14 (where a PEG of 1.0 is considered fairly priced) means it is very over-valued. It currently has a P/E of 17 and is expected to grow 1.4% to $2.28 in 2012.
Pfizer has yet to show it can come up with enough new patented products to offset the loss of revenue it will suffer as its leading drug comes off patent and faces competition from generics. It may be in the recovery room but its vital signs are not yet strong enough to release it from the hospital.

If you like a high dividend yield and can wait for the chance that it might revive its R&D pipeline, buy the stock. Otherwise, I think Pfizer has a lot of growing to do before it can justify its current exorbitant valuation.


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