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Pfizer: A pill worth swallowing?
Lipitor ruling removes a big hurdle for Pfizer's stock, but does that make it a buy?
December 19, 2005: 9:23 AM EST
By Bethany McLean, FORTUNE senior writer
New profit twist
Patent losses can decimate sales but drugmakers are finding new ways to wring profits from products. (Full story)

NEW YORK (FORTUNE) - After the market closed on Friday and trading floors began to empty for the holidays, there suddenly came long-awaited and momentous news about one of the world's biggest companies.

A federal judge rejected a patent challenge against Pfizer's (Research) drug Lipitor -- a challenge that, if successful, would have resulted in Pfizer losing its monopoly on the world's best-selling drug as early as next year.

The challenger, an Indian drug company named Ranbaxy, says it will appeal, but the decision looks strong, and Pfizer is likely to maintain its Lipitor monopoly until 2011.

Because Lipitor accounts, by some estimates, for as much as a third of Pfizer's profits, the shock of relief sent Pfizer's stock up some 11 percent in after-hours trading, to around $25.

Indeed, the news about Lipitor removes a major overhang that helped sink Pfizer's stock to an eight-year low last week. It's tempting to think that even with the rally, now is the time to buy.

How often do you find an over-150 year old, triple-A rated company that generates tons of cash and just raised its dividend selling for around 11 times forward earnings estimates?

But of course, the story behind Pfizer's decline -- along with the decline of the rest of Big Pharma -- is a much bigger story.

It's the story of an onslaught of competition from generic drugmakers, evermore noise about high drug prices, increased litigation, patent expirations, too-empty pipelines -- and the near-impossibility of 15 percent annual earnings growth when you're already a behemoth the size of Pfizer.

How can you possibly account for all that uncertainty?

The short answer is, you can't.

Pfizer itself can't, which is why last fall, the company abruptly suspended the earnings guidance it had long provided to investors. In February, Pfizer will announce its fourth-quarter results, and many are eagerly awaiting that event to see if Pfizer will be able to offer a clearer picture of the future.

According to Thomson Financial, 12 of the Wall Street analysts who cover Pfizer rate the stock "neutral," which is fairly bearish for the Street.

Steven McIntyre and Todd Stein, who are the authors of Texas Hedge, a monthly newsletter that analyzes the markets, don't pretend to have any easy answers.

Nor are they Pollyannas. As they note on the front page of their newsletters, they have an "extensive background in short selling and junk bonds, which has enabled us to see the dark underbellies of many once-loved companies. As such, we view all potential investments with an extremely skeptical eye."

But they are ardent fans of Graham & Dodd --the fathers of value investing -- and they've applied the duo's principles to Pfizer's financials.

Like many who believe in fundamental analysis, the guys at Texas Hedge begin by looking at a company's cash.

They start with free cash flow -- basically, the cash a company produces after capital expenditures and changes in working capital. Pfizer, they note, produced almost $14 billion of free cash flow in 2004, and is on track to produce over $10 billion in 2005. (Patent expirations on key drugs account for much of the decline.)

In addition, Pfizer's balance sheet reveals net cash of over $4.5 billion. Over the last few years, Pfizer has spent some $41 billion on dividends and net share buybacks. In essence, that's money it has returned to shareholders. Pfizer may or may not be a growing company, but it is not an unhealthy one.

If you could be sure that Pfizer could duplicate this track record, then you could buy -- even after the Lipitor relief rally -- with some degree of confidence.

As Texas Hedge notes, if Pfizer "can put to work another $40 billion over the next four years for shareholders in the form of dividends and stock buybacks, without impairing its cash position, we think the stock will almost necessarily be higher, as over a quarter of its enterprise value will have been repaid to shareholders in one form or another."

That "if," as they note, is the big question. Even so, investors who are searching for a stock with at least a margin of safety in today's increasingly frothy environment could certainly do worse than Pfizer.


The Pfizer ruling gave investors in the sector some holiday cheer, click here for more.  Top of page

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