Published on July 10th, 2019 by Eli Inkrot
Pfizer (PFE) is a global biopharmaceutical company that has been around for over 150 years. The company discovers, develops and manufactures medicines, vaccines and many of the world’s best-known health care products.
Pfizer has a market capitalization of $245 billion, making it a mega-cap stock. Pfizer is also a member of the Dow Jones Industrial Average.
The Dow Jones Industrial Index member has now paid a dividend for 322 consecutive quarters and trades with a current dividend yield of 3.3%.
This article will discuss Pfizer’s business model, and why the stock may be slightly overpriced right now.
Business Overview
At the start of 2019 Pfizer reorganized its operations from two segments – Innovative Health (IH) and Essential Health (EH) – into three businesses:
- Pfizer Biopharmaceuticals Group
- Upjohn
- Consumer Healthcare
The Biopharmaceuticals Group is a science-based innovative medicine business. This segment of Pfizer includes all of the old Innovative Health businesses (expect Consumer Healthcare) as well as a new Hospital business unit and contract manufacturing, Pfizer CentreOne. Top products include Eliquis, Ibrance, Prevnar 13, Enebrel (international), Chantix, Sutent and Xeljanz.
Upjohn is a global, off-patent branded and generic established medicine business, which includes the majority of Pfizer’s off-patent solid oral doze legacy brands, including Lyrica, Lipitor, Norvasc, Viagra and Celebrex. This unit has fully-dedicated manufacturing, marketing, regulatory and enabling functions, allowing the segment to operate as a stand-alone business within Pfizer.
Consumer Health includes Pfizer’s over-the-counter medicines such as Advil, Nexium, Caltrate, Centrum, Chap Stick, Robitussin, and more.
Growth Prospects
Pfizer began reporting top-line results for each segment starting with the first quarter of 2019. The biopharma unit’s strong 7% quarter-over-quarter operational improvement was driven by 36%, 25%, 10% and 34% increases from Eliquis, Ibrance, Prevnar 13 and Xeljanz respectively.
Specifically, oncology remains a focus within Pfizer’s growth plan.
Source: Investor Presentation
The Upjohn segment saw 25% improvement in emerging markets, which was almost entirely offset by declines in developed markets.
Consumer healthcare saw a moderate decline, as 4% operational growth in international markets was offset by an 8% decline in the U.S.
On a company-wide, annual basis Pfizer generated $53.6 billion in annual revenue in 2018, to go along with $11.1 billion in reported net income or $18.0 billion in adjusted net income. Earnings-per-share equaled $1.87 on a reported basis or $3.00 on an adjusted basis, which excludes certain items, such as intangible amortization (a real cost in our view).
During the past decade Pfizer’s top-line growth has not been particularly impressive – moving from $48 billion to less than $54 billion – good for an average compound growth rate of just 1.1% per annum. However, this alone does not dictate a growth thesis.
Due to margin expansion, Pfizer has been able to grow company-wide net income from under $8 billion to over $11 billion in the last decade for a growth rate of 3.4%. Moreover, as result of significant share repurchases, earnings-per-share have increased by an average compound rate of 4.7% per annum for the last 10 years.
This is not spectacular growth, but it does illustrate that there is more to the growth equation than revenue results alone. Further, shareholders actually saw their investment compound by nearly 12% per year since the end of 2008, as moderate growth coincided with a substantial uptick in valuation to go along with a solid dividend yield.
Dividend Analysis
Pfizer has an enviable claim of having paid a dividend for over 80 consecutive years. However, this company does not command an unusual amount of respect due to the company’s decision to cut its dividend during the last recession.
Pfizer has paid a dividend for many years, but the dividend was actually cut in half in 2009. To be sure the dividend cut in 2009 would have been unpleasant for income investors. However, otherwise Pfizer has been a solid income provider and in the last decade, significant strides have been made in this area.
In 2003 Pfizer was paying out 34% of its profits in the form of cash dividends. This reached 53% in 2007 and 108% in 2008 as the recession hit earnings particularly hard; hence the dividend cut.
Since that time, Pfizer has been keeping dividend growth more or less in-line with earnings growth. In the 2010 through 2018 stretch, Pfizer grew earnings-per-share by 7.7% annually, while the dividend has increased by 8.3% per annum.
Today the company’s payout ratio sits at 73% of expected profits (~51% of adjusted profits) and shares trade hands with a 3.3% dividend yield.
Recession Performance
Here’s a look at Pfizer’s earnings-per-share results during the last recession:
- 2007 earnings-per-share: $2.20
- 2008 earnings-per-share: $1.18
- 2009 earnings-per-share: $1.23
- 2010 earnings-per-share: $1.03
You can see that the recession hit the company particularly hard. During this time the dividend was cut, and the share count increased 20%. This is an instructive bit of information and gives a prospective investor some insight into the type of dilutive action that may be required in lesser times.
It is notable that Pfizer was still very profitable during this time; however, earnings were cut in half and the company has yet to eclipse its prior pre-recession peak, despite a significant share repurchase program in the interim.
Valuation & Expected Return
Pfizer currently trades hands around $43. Compared with expected earnings of ~$2.00 per share, that equates to a valuation multiple of roughly 21.5, against a typical multiple closer to 19 or 20 times earnings.
Compared with the mid-point of expected adjusted earnings ($2.87) shares presently trade hands around 15 times earnings, just above the typical average adjusted P/E ratio of 13 or 14 times earnings. As a result, Pfizer stock appears to be slightly overvalued.
For our purposes, we will use $2.00 in earnings-per-share with an average multiple of about 19 as a starting baseline. We expect mid-single-digit EPS growth for Pfizer over the next several years, which we believe to be a reasonable starting point. While the company is very large, it does have a number of opportunities in its pipeline:
Source: Pfizer Q1 2019
For illustration, suppose that Pfizer is able to grow earnings-per-share by 6% per annum – a bit above its historical rate, but within the same ballpark. At that rate, $2.00 in underlying earnings power would turn into $2.65 or so in earnings-per-share after a half decade. Using an average multiple of 19 times reported earnings, this would equate to the potential for a ~$50 share price.
Pfizer’s dividend presently sits at $0.36 per quarter or $1.44 on an annual basis. If this were to increase by the same 6% yearly rate, you would anticipate collecting ~$8 or so in cash dividends. That works out to a total nominal baseline of ~$58 in value after five years, keeping in mind that this is merely a starting point out of an infinite number of possibilities.
Whether or not ~$58 in potential value after five years is attractive, depends on the current share price. If shares were trading at $58, naturally a 0% expected return would not be interesting. With a $43 share price today, this works out to the potential for a 6.2% annual gain. And remember, we were using a slightly above average growth rate in this instance.
In order for returns to be higher than this mark you would need to see even higher earnings growth, larger dividend payments or an above average valuation multiple in the future; none of which have a great deal of precedent.
Final Thoughts
Pfizer has been a solid company for the last 150+ years and that trend does not appear to be stopping anytime soon. The company has an enviable combination of strong brand names coupled with an immense R&D budget.
In the past decade, shareholders saw solid returns as a result of reasonable growth, dividends, as well as a significant uptick in the valuation multiple.
Moving forward the modest (albeit unspectacular) growth thesis and reasonable dividend are still intact. However, today’s valuation leaves a bit to be desired. This last item in particular could set up for mediocre investment results from this point, making Pfizer stock a hold thanks to its hefty yield, but not a buy.
