The case for Pfizer
The healthcare giant faces a steep patent cliff - but it has the cash to bridge it.
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| CEO Jeff Kindler drastically reorganized Pfizer last year. |
NEW YORK (Fortune) -- At first glance, Pfizer seems more virile than ever. The pharmaceutical giant has a sector-leading $26 billion in cash, and its profits last quarter were triple the year before. Pfizer's portfolio includes household names such as Viagra, the famous blue impotency pill, and Lipitor, the anti-cholesterol drug that is the world's best-selling medication.
But Pfizer's prognosis isn't as glowing as it appears: Lipitor, which composes 26% of Pfizer's revenues, will lose its patent protection in the fall of 2011. When that happens, cheap generics will hit the market and, most likely, gobble up most of Lipitor's $12 billion in annual sales.
While Pfizer (PFE, Fortune 500) isn't the only pharmaceutical company with a generic problem (top-selling drugs from Bristol Myers-Squibb and Merck are also going off patent soon), its exposure is the greatest. Prudential Equity analyst Timothy Anderson estimated that drugs composing 41% of Pfizer's sales will go off patent between 2010 and 2012.
Shareholders have pressed CEO Jeff Kindler for a new source of revenue, but none of the company's recent drug trials - most notably, Torcetrapib, which was supposed to replace Lipitor - have panned out. The market has taken notice: Pfizer is trading at $16 a share - 40% below its value when Kindler took its helm. Its competitors' shares have also dropped in that period, but Pfizer's has decreased the most.
But while Pfizer seems to be headed towards a cliff, it's worth hanging on to its stock. The company has been quietly reinventing itself, and it has the cash - and, now, the desperation - to turn it around.
In recent months, Pfizer's stock has been beaten down: Investors are valuing it at a 25% discount to its peers, says Steven Lichtman, an analyst at Banc of America Securities. The company's trailing price to earnings ratio is 6.95, and its forward P/E, which is based on projected earnings, is 6.4 - the best value in pharma. "The price of Pfizer reflects the known issues - the generic threat to Lipitor," says Lichtman. "But it doesn't take the opportunities into account."
Lichtman points to Pfizer's pipeline of 114 drugs, 25 of which are in the final stage of clinical trials before being submitted for FDA approval, as a sign of the company's promise. Pfizer is working on a treatment for rheumatoid arthritis that he thinks could yield as much as $4 billion a year. "They have more shots on goal than their peers," says Lichtman. Merck (MRK, Fortune 500), which is trading at $26, has nine drugs in late-stage trials (Lichtman notes that some of those, such as a migraine treatment, could be big moneymakers).
In recent years, Pfizer has failed to convert - turn those shots into huge successes. But the company is no longer single-mindedly bent on finding the next Lipitor. Kindler drastically reorganized Pfizer last year, breaking it up into small, more focused units to increase accountability. The company has also shifted its focus from obesity and heart disease to lucrative fields such as Alzheimer's and cancer, which are more cost-prohibitive to generics.
Deutsche Bank analyst Barbara Ryan believes that investors have failed to factor in Pfizer's cultural change. "PFE's new management team continues to work on a fundamental transformation of the company from a monolith; bloated and highly centralized structure, into an operationally leaner, nimble, and customer-centric business," she wrote.
Another testament to Kindler's vision: One of the company's new units is focused entirely on emerging markets. While Pfizer had made cuts at home, it's boosting its sales force in China. The company now derives 58% of its revenues internationally; Lichtman notes that 13% of Pfizer's sales now come from Asia, compared to the 10% industry average.
The company's inroads in the region could pay off big - Pfizer estimates that the Asian market will be worth $100 billion by 2017. The company aims to be the dominant drug maker in six of the seven emerging markets it's targeting by 2012.
A quicker way for Pfizer to compensate for the loss of Lipitor would be to purchase another company. "They have a lot of cash to go out and buy things right now, and they need to bring in innovation," says Daniel Ruppar, an analyst at Frost & Sullivan.
While stockholders have criticized Kindler for sitting on his pile of cash ala Scrooge McDuck, Pfizer may be at its breaking point - the company needs to buy something. Pfizer has been slow to spend in recent years, but prices have dropped severely as markets have swooned. Ruppar predicts that Pfizer will follow the lead of Bristol Myers-Squibb (BMY, Fortune 500), which recently purchased ImClone, and invest in biotech, an industry that's full of innovators. Pfizer has enough dough to go after a fish as big as Gilead, a current analyst favorite.
Management has been vague about what it plans to buy, but it has pinpointed one area: Pfizer just invested $100 million in stem cell research. Many predict that Pfizer will soon start ingesting companies that study stem cells. The market opportunity there is still unclear, but Ruppar says there's blockbuster potential - and is more optimistic about the field after Obama's election.
Pfizer has other advantages over its rivals: In addition to having the most cash, it has the highest gross margin in its industry, and its debt-to-equity ratio (the amount it owes divided by the amount that shareholders have invested in it) is 24%, vs. 35% for Merck and 59% for Wyeth. Pfizer has deftly managed its liabilities through cost-cutting efforts, which will yield $2 billion in savings this year.
Even more tempting: The company pays an 8% annual dividend, the largest in its sector.
While some analysts are worried that the company can't sustain that yield, Pfizer CFO Frank D'Amelio recently assured shareholders that the payout is safe, "significant events aside." A dividend won't cure Pfizer's Lipitor woes, but it's good reason to buy in - and wait for the healing to begin. 
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