Pfizer (NYSE: PFE) is the country’s largest prescription drug maker, has strong free cash flow, lots of cash, the third-highest dividend yield among the 30 Dow stocks, is attractively valued compared to its peer group, and is rated a “Buy” by 13 of the 20 Wall Street analysts who follow it.
That’s a lot of reasons to buy the stock, but I don’t think they’re good enough. In fact, I recommend that if you own PFE you should close out your position, because there are better opportunities.
PFE closed at $28.47 today, where it traded at 17.7 times trailing 12-month earnings, and pays an annual dividend of $1.04, for a yield of 3.6%. To put those numbers in perspective, the average stock among major drug manufacturers trades at a P/E ratio of 21.6 and carries a dividend yield of 3.46%. So, by those measures Pfizer stock is undervalued.
But from where I sit, Pfizer is a troubled company. The biggest issue is that its revenues are declining as it loses sales from prescription drugs – like Lipitor and Viagra – that have lost their market exclusivity or for which their joint marketing agreements with other drug makers have expired or are about to.
In fact, of Pfizer’s 25 biggest-selling drugs, 15 of them chalked up sales declines last year. This record contributed to a 7% decline in company revenue last year to $51.5 billion. It was the fourth year in a row that PFE sales shrank – they reached a high of $67.8 billion in 2010 – and revenue is still below the $52.5 billion the company reaped in 2004.
Unfortunately, analysts aren’t overly impressed with the prospects for the new drugs in Pfizer’s pipeline: they project that PFE’s earnings will grow at just 3.1% year over the next three to five years.
That’s one of the reasons Pfizer tried to buy London-based AstraZeneca (NYSE: AZN) for $119 billion this year (it has a market cap of around $85 billion). It coveted AZN’s line and pipeline of cancer-treatment drugs, an area where Pfizer stock is weak.
The trouble is, even if Pfizer lands a pharma acquisition, it has a history of overpaying for them. For example, it took years for it to digest its 2009 purchase of Wyeth Pharmaceuticals, for which it paid $68 billion. Even though it paid only half of the price in cash (the rest in shares), the crunch caused the Pfizer board to slash the dividend by 50%, to 64 cents from $1.28 – a level it still hasn’t returned to.
My concern is that if Pfizer succeeds in making the big acquisition it needs for growth it might well take the axe to the dividend once again. On the other hand, if it doesn’t get its hands on someone else’s prospective blockbusters, investors will have to settle for mediocre returns.
Pfizer stock does have some things going for it. It enjoys healthy margins, has consistently generated between $13 billion and $18 billion in annual free cash flow for the last 10 years, and is sitting on more than $5 billion in cash. It also boasts a manageable debt to equity ratio of just 46%, less than half the industry’s average.
So, without an acquisition, PFE’s dividend looks safe. It is also committed to a $10 billion share buyback program last year. At the time, it was the company’s fourth buyback program announcement in a span of 30 months, and it’s been a major part of the reason the stock produced strong returns the last few years.
As things stand, I’m uncomfortable with PFE’s strategic position – it presents too much uncertainty and too little growth for my taste. Things may turn out well for PFE holders, but I think the prospective risk-reward ratio is much better elsewhere.
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