Marcial: The Formula for a Pfizer Recovery

The pharma stalwart is unloved by investors, but a cost-cutting program and an increased emphasis on cancer drugs could bring new life to the shares

A glance at the stock chart of Pfizer (PFE), the world's largest pharmaceutical company, could make you sick—if you own the stock. It is now trading at its 52-week low of $17.96 a share, down from $27 a year ago and way down from $50, where it was in 2000. After the vertigo, nausea, and other side effects of experiencing such a precipitous plunge, you might even think about calling your broker, if you haven't already, to sell the stock.

Bad move. That would be financially unhealthy. Selling when a stock is trudging lower is a reckless idea. That is precisely the time to buy, and in the case of Pfizer, it's definitely bargain-hunting time for long-term investors.

The bad news dogging Pfizer is that it hasn't had any good news for some time. But even so, and despite the many naysayers, the stock is undervalued. On both technical and fundamental grounds, there are reasons for long-term investors to be bullish. The bad news is already well reflected in the stock. But the good news isn't, and any positive development at this point would quickly set the stock on fire.

A Short History of Pfizer

Why do I say that Pfizer is undervalued? Let's look at the history of the stock: Over the past 20 years, Pfizer's price-earnings ratio hasn't been as low as it is now. The average price-earnings ratio of the stock ranged from a high of 51 in 1998 to a low of 11.5 in 2007. Today, the stock's p-e, based on estimated earnings of $2.35 a share, is a meager 7.6, and it goes down to 7 when based on 2009 estimated earnings of $2.56. That argues strongly that Pfizer is way underpriced.

Barbara Ryan of Deutsche Bank (DB), who rates Pfizer a buy, has a 12-month price target of 30. At that price, the stock's p-e would be 12.7 on estimated 2008 earnings, and only 11.7 on 2009 profit forecasts. So even at 30, the stock would be trading at historically reasonable levels.

And there is the enticing dividend yield that Pfizer provides while investors wait for the stock to recover. Its yield of 6.6% is the highest in the industry, and contrary to what the bears contend, the payout stands on solid ground. "We believe stability in the $1.28-a-share dividend is a high priority, and Pfizer will continue to adjust costs to maintain it," says Herman Saftlas of Standard & Poor's, who rates the stock a hold. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies.) Deutsche Bank's Ryan believes there is no issue to worry about as regards the company's ability to fund the dividend, given that Pfizer has a hefty $35 billion in cash and just $7.3 billion in long-term debt. In 2008, she estimates Pfizer will generate $17.3 billion in free cash flow.

The bears caution that Pfizer's earnings are dwindling, as reflected in declining sales of its cholesterol treatment Lipitor in the face of competition from generic versions. First-quarter results were, indeed, dismal compared with the Street's expectations. Revenues could well disappoint again over the short term, but the bulls aren't that concerned about earnings. They point out that over the years, Pfizer has been able to steadily increase profits, in part by managing overall costs. Pfizer has a cost-restructuring program that is expected to produce savings of up to $2 billion by the end of 2008. And the bulls are confident Pfizer will come out with new products in time to fill the shortfall that will come from the expected Lipitor sales slowdown.

Confirmed 2008 Earnings Forecast

In spite of the lackluster first-quarter results, Pfizer's management has reiterated its guidance for all of 2008, forecasting $47 billion to $49 billion in revenues. Kavita Thomas of First Global Markets, who rates Pfizer "moderate outperform," expects flat revenue growth but sees earnings growing at 7% to 8% in the next two years, based on management's aggressive cost-cutting measures and potential new drugs.

Thomas' estimate is in line with Pfizer's historical growth rate. Thomas expects operating profit margins to jump to 42% in 2008 from 2007's 37%, and the return on equity to rise to 26% from 2007's 21%.

One reason behind the stock's recent drop—from $19.40 a share on May 29 to $18.52 on June 5—was Goldman Sachs' June 5 downgrade to neutral from buy. Goldman analyst James Kelly emphasized what's been obvious all along: The company is facing "substantial growth challenges because of Lipitor," the world's largest-selling cholesterol-lowering agent and the biggest drug in any therapeutic category, which produced sales of $12.7 billion in 2007. Lipitor loses its patent protection in 2011. That's the biggest hole Pfizer has to plug. Lipitor accounted for 26% of Pfizer's total sales in 2007. Undoubtedly that is what's scaring investors.

Kelly notes that since Goldman added Pfizer to the firm's buy list on Jan. 4, 2007, the stock has fallen 28.7%, vs. a 2.9% drop by the Standard & Poor's 500-stock index. On June 2, just a few days before Kelly downgraded the stock, he had reiterated his buy recommendation. In this earlier report, the headline was "Pfizer's oncology pipeline continues to show promise." He noted that in its presentation at the recent American Society of Clinical Oncology conference in Chicago, Pfizer disclosed data about its line of oncology products that challenged "standard-of-care therapies head-on, including lung cancer, pancreatic cancer, kidney cancer, and liver cancer." No single product, Kelly argued, "could fill Pfizer's patent hole, but oncology could represent a major contribution." (Goldman has done investment banking for Pfizer.) Kelly is now one of 14 analysts who rate Pfizer a hold, vs. 8 who recommend it as a buy. Two have outright sell recommendations.

The Future Lies in Compounds

The loss of patent protection on some of its other major products, including Norvasc, Pfizer's cardiosvascular drug, has reduced the company's overall sales. But let's not forget that all this unnerving stuff is already reflected in the stock price. The good stuff—the compounds that Pfizer is banking on for future growth—isn't yet reflected in the stock. One example: The company's emphasis on cancer drugs, where it is ramping up spending on research and development.

Pfizer says its oncology R&D pipeline is "robust and growing." Some 22% of its overall budget is now dedicated to oncology R&D projects, currently with 22 innovative compounds in clinical development. Pfizer's oncology unit expects to start seven Phase II studies this year, focusing on four types of cancer: non-small-cell lung cancer, renal cell carcinoma, prostate cancer, and hepatocelluar cancer. Apart from its oncology projects, Pfizer has 16 molecules in its pipeline that are in Phase III clinical trials, of which four are for follow-on indications in already approved products. "Pfizer has the largest Phase II pipeline in its history, and it wants to have 15 to 20 regulatory submissions between 2010 and 2012," notes Thomas of First Global markets. Pfizer's goal is to have up to 28 late-stage programs by the end of 2009.

The big problem for Pfizer's stock is that investors have become impatient because of its sluggish performance in the past two years. But those who take advantage of this cellar dweller now should receive a healthy bounty in a year or two, maybe even sooner.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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