Pfizer (PFE) is a blue-chip pharmaceuticals company. It has 101 drugs in its pipeline, and nine existing blockbusters each with over $1 billion in annual revenues, most with patents not expiring until 2026, and several of them growing significantly. The company’s increased and impressive growth expectations stem from its strategic streamlining effort through divestitures and acquisitions, as well as a new focus on biopharma. And despite the recent terrible performance of drug stocks in general (President Trump is now leading the effort to bring down drug prices), Pfizer’s dividend is very healthy, the yield is unusually high, and if you are a contrarian investor—the shares are absolutely worth considering for a spot in your prudently-diversified, long-term, income-focused portfolio.
Members-Only Note:
We allowing this stock-specific investment idea (PFE) to double as our Blue Harbinger Weekly this week, because we are giving consideration to replacing another Dow Jones stock in our portfolio (Procter & Gamble) with shares of Pfizer. We have owned Procter & Gamble (PG) for several years now, and its recent strong performance has been truly impressive (+50% over the last year) while Pfizer’s performance has been so weak (it’s down a lot). We’ll let members know right away if we pull the trigger on this long-term trade idea. In the meantime, here is our write-up on Pfizer…
Overview:
Pfizer is a research-based global biopharmaceutical company engaged in the discovery, development and manufacture of healthcare products including medicines and vaccines. PFE is an industry giant and has recorded more than $50 billion in total revenues consistently over each of the past three years. The company sells its products in over 125 countries through a network of ~92,400 employees. PFE spends significantly on the development of drugs with R&D expenditures equal to ~15% of total revenue in each of the past three years, resulting in a pipeline of over 100 projects in clinical research and development currently.
PFE operates through three segments: Pfizer Biopharmaceuticals Group (“Biopharma”), Upjohn and Consumer Healthcare. The company’s largest segment, Biopharma, focuses on six fields of treatment, namely Oncology, Inflammation & Immunology, Rare Disease, Hospital, Vaccines, and Internal Medicine. The company’s portfolio includes several legacy brands such as Prevnar 13 (pneumococcal vaccine), Xeljanz (arthritis), Eliquis (atrial fibrillation), Lipitor (cardiovascular disease), Celebrex (arthritis), Pristiq (depression), Viagra (erectile dysfunction) and Lyrica (epilepsy). As such, PFE’s portfolio is well diversified, addressing a wide range of medical conditions. Further, many of these drugs have inelastic demand (people won’t stop using them in a recession) and provide stable cash flows for the company.
Strategic spin-offs and mergers
In 2019, PFE initiated a restructuring plan to become a relatively smaller science-based company with a singular focus on innovative pharma, while creating specialized, pure-play spinoffs for the other segments. Specifically, Pfizer announced an Upohn-Mylan merger and Pfizer-GlaxoSmithKline joint venture (more on these in a moment). Basically, the restructurings are aimed at providing a larger scale to each business segment to help secure their positions within the respective marketplaces.
Regarding Upjohn-Mylan, in July 2019 Pfizer announced that its off-patent branded medicines business, Upjohn, will be merging with Mylan, a global generic and specialty pharmaceuticals company, to create a new entity. Given Upjohn’s firm presence in Asia and emerging markets, and Mylan’s strong footprint in US and Europe, the new company will have a truly global reach. According to a Pfizer presentation, PFE shareholders will have a 57% stake in the new company which is expected to generate ~$20 billion in revenues and >$4 billion in free cash flows in 2020 while targeting a ≥25% payout. Additionally, PFE will be receiving an infusion of $12 billion cash from the new company, which will be used to repay its own debt, freeing up additional cash flows for future dividends.
Regarding Pfizer-GlaxoSmithKline, in August 2019 they announced a joint venture to combine their respective consumer healthcare businesses to create the world’s largest over-the-counter business. Assimilation of these businesses is expected to produce cost synergies and scale advantages. PFE shareholders will own a 32% equity stake in this new entity.
Key products driving sustained top-line growth
PFE’s portfolio is fundamentally strong with nine of its drugs having annual revenues greater than $1 billion. The largest contributor among these was Prevnar 13, a pediatric vaccine with $5.8 billion in revenues in 2018. While the drug seems to have reached saturation within the US market, it has been picking up strongly in China since its launch there in 2017. Apart from this, the outlook for the future remains significantly positive, attributable to several drugs that have demonstrated strong growth and will be key to the company’s sustained performance over the coming years. Specifically:
Ibrance, an oral combination treatment for advanced breast cancer recorded $4 billion revenues in 2018. Revenues from the drug grew 22% in H1 2019, driven by strong volumes in international markets. Going forward, Ibrance is expected to remain a key contributor to the company’s revenue.
Xeljanz, a drug used for the treatment of arthritis, recorded $1.8 billion revenues in 2018. Revenues from the drug grew 31% in H1 2019, and looking ahead, it is expected to generate estimated revenues of ~$3 billion by 2022.
Xtandi, the first oral drug to be approved for certain types of prostate cancer, is a leader in its line of treatment. Revenues from the drug have grown by ~12% in H1 2019 and it is expected to contribute over $1 billion in revenues by 2021 increasing to $1.5 billion by 2024.
Another reassuring aspect of PFE’s portfolio is that with the exception of Lyrica (part of Upjohn), no other product has a patent expiry until 2026. While Lyrica’s patent expiry in June 2019 will have an adverse impact on sales this year, the long-term impact will be mitigated due to Upjohn’s merger with Mylan in 2020. We remain confident in the strength of the remaining portfolio to more than compensate for this impact and sustain the company’s revenues going forward.
Strong pipeline, future revenues
With Pfizer now directing its efforts toward biopharma, pipeline strengths are now key to success. In this regard, Pfizer has 101 products in the pipeline as of July 2019, out of which 9 are already in the registration process.
Management expects the company to grow at a CAGR of high mid-single digits over the next five years (based on the strength of this pipeline and the company’s new more-concentrated size). According to CEO Albert Bourla during the Q2 2019 earnings call:
“We believe we will be in a position where our pipeline will be able to move the needle even more dramatically in terms of our long-term growth prospects. In fact, we see our growth profile improving in three ways. We expect our five-year revenue CAGR to be higher than it otherwise would have been. We see the growth starting earlier because the Lyrica LOE cliff will go away. And given our smaller size, we believe that growth will be more sustainable.”
In Q2 2019, PFE received FDA/European Commission approval for 7 new products. Some of these are firsts in their line of treatment and address a range of diseases with unmet needs. One of them is Vyndaqel, the first and only FDA-approved drug to reduce cardiovascular mortality and cardiovascular-related hospitalization. While PFE will need to grow awareness and educate physicians and cardiologists regarding the drug, it is expected to generate ~$1 billion in revenues in 2021 as per consensus estimates.
Tanezumab, another pipeline drug in Phase 3 development, is expected to have a bright future in the wake of the opioid crisis. It is a nerve growth factor inhibitor used to treat pain, with straightforward benefits given the need for non-opioid alternatives to pain treatment. The company is sizing up this drug at a $1 billion potential.
Acquisitions to enhance portfolio
While the company has invested heavily in strengthening its pipeline, Pfizer has not shied away from attractive M&A opportunities which complement its portfolio. In July 2019, PFE acquired Array Biopharma, a biotech firm specializing in cancer drugs, for an enterprise value of $11.4 billion. Array brings with it an impressive portfolio including an FDA approved combination treatment for patients with melanoma - the deadliest form of skin cancer, and an industry-leading therapy in colorectal cancer. This will enhance Pfizer’s Oncology portfolio and further accelerate growth.
According to CEO Albert Bourla during the Q2 2019 earnings call:
“We believe Array's assets fit neatly into our business and we expect the three key drivers of the acquisition, the colorectal cancer opportunity, the existing royalty stream, and Array's research platform to become solid contributors to Pfizer's growth potential as we move into the next decade”
Earlier in May 2019, Pfizer also acquired Therachon, a clinical-stage biotech company (with a standout drug for treatment of achondroplasia) for $810 million. While the deal is expected to enhance Pfizer’s rare disease portfolio, the acquisition is risk adjusted with $470 million of the total consideration to be paid only after the successful commercialization of achondroplasia.
Attractive investment opportunity
Pfizer’s large scale, successful product portfolio, promising pipeline and high dividend yield (this is a signal from management, in our view) make it an attractive investment opportunity. The company has a history of using its huge cash flows to generate strong returns for shareholders through both dividends and share buybacks.
(data source: Factset)
Through H1 2019, the company has already bought back shares totaling $8.9 billion while total share repurchases in 2018 were $12.2 billion.
Further, Pfizer’s current dividend yield of 4.2% is significantly higher compared to 2.9% for the Dow Jones Industrial Average and 1.9% for S&P 500. In our view (and if you are a “Dogs of the Dow” theorist), this is a strong signal from management that the share price should be trading significantly higher. And for what it’s worth, most Wall Street analysts agree the shares are significantly undervalued. Specifically, the following chart shows the Street believes the shares have significant upside potential over the near to mid-term (and we believe it’s even more over the long-term).
(source: Factset)
Risks:
Pfizer has narrowed its focus to biopharma while simultaneously providing scale to its other segments through spinoffs and mergers. While this move is attractive in our view, it comes with a few inherent risks. For example, patented drugs have a steep lifecycle, whereby they can be extremely profitable while they are patented, and then face eroding profit margins when patents expire. While Pfizer’s Upjohn and Consumer Healthcare segments provided a certain degree of protection through this lifecycle, its ongoing restructuring plans reduce this insulation to some extent. Pfizer will increasingly have to rely on its pipeline of new products which will require substantial R&D investments and the typical lifecycle volatility.
Nonetheless, Pfizer currently has the strongest pipeline it’s had in the past decade, with several drugs already approved and ready to be commercialized. And as readers are well-aware, just a few successful products can be more than enough to generate billions of dollars in revenues and more than compensate for those that don’t make it through the multiple stages of clinical development. Moreover, the scale of the company allows easier access to capital markets and the ability to generate very strong cash flows thereby maintaining important R&D expenditures.
Conclusion:
With a purposeful focus on biopharma, combined with strategic spinoffs and mergers, and a strong product pipeline, Pfizer offers investors and attractive mix of dividends and capital appreciation potential. More specifically, Pfizer’s dividend yield is strong, significantly higher than normal, and a signal from management that the shares should be trading higher. The recent underperformance of the entire healthcare sector (and drug companies in particular) combined with the dynamics of Pfizer’s strategic streamlining have created an attractive opportunity for contrarian investors. If you are a disciplined, long-term, income-focused investor, Pfizer is absolutely worth considering.