I have not been impressed by Big Pharma for many years. I recall reading an article in the late 1990s that said that Big Pharma was going to be in big trouble as more and more drugs came off patent. And subsequently, as a retirement stock holding, Big Pharma supposedly was going to cease making sense.
As predicted, for the past 15 years, these companies have not done much in terms of organic EPS growth. Instead, they’ve used stock buybacks and other financial engineering to make them appear more profitable than they are.
Nevertheless, investors like Big Pharma because the companies make tons of free cash flow and pay dividends — albeit not that much on a risk-adjusted basis. I just don’t like paying a mid-teens multiple for a company with under 5% organic EPS growth paying a 3% dividend.
There’s a lot less risk and higher yields in preferred stocks.
Pfizer Inc. (NYSE:PFE) and Eli Lilly and Co. (NYSE:LLY) recently received some good news from the FDA, which permitted the companies to go to Phase 3 trials for their terminal cancer pain drug, tanezumab. The FDA had put a partial hold on the PFE and LLY drug because of concerns related to adverse events that led to joint replacement. The FDA thought a drug for chronic pain that necessitates joint replacement was unacceptable. Of course, terminal cancer patients don’t have those concerns, so the FDA let that part of the PFE and LLY trial continue.
Is this the kind of drug that can add significantly to Pfizer’s coffers? It might be, but I’m not sure it makes me feel any different about the stock.
The Bear Case for Pfizer Stock
Here are a multitude of reasons why I think buying, or even holdings, PFE stock is not a good idea:
For one, Pfizer earnings for FY15 are expected to decline from $2.26 per share to $2.09, and worse, it’s coming on a 6.2% decline on revenue. That right there is enough to scare me away from Pfizer stock. PFE’s “rebound” to $2.23 doesn’t impress me, either.
Analysts estimate five-year annualized earnings growth of just 2.17%. If you add in the 3.3% yield, a base fair value for PFE would be a mere $12, or 5.5 times earnings … yet PFE stock trades at $34.
Of course, I like to make some adjustments for cash and other factors to get a more complete sense of the valuation.
Pfizer’s $17 billion in net cash and investments comes out to about $2.75 per share, bringing the effective price of PFE stock down to $31.25. All that excess cash triggers a 10% valuation bonus in my books.
Its incredible free cash flow triggers another 10% bonus. PFE has very consistent capex of $1.1 billion to $1.3 billion per year, and very consistent operating cash flow of $16.7 to $17.7 billion annually, giving it free cash flow of $15.4 billion to $16.4 billion annually.
Finally, I give another 10% bonus on valuation for PFE stock being a world-class brand name.
Add that up, and the original 5.5x fair-trade calculation is bumped up to 7x. Problem is, even if the figure was double that, Pfizer — which currently is trading at around 16 times next year’s earnings — would be overvalued.
Maybe that’s why PFE has such healthy short interest.
Pfizer is not a stock for any investor, much less a retirement stock. I say you should sell PFE if you’ve got it and stay away.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He is the manager of the forthcoming Liberty Portfolio, has 20 years’ worth of experience in the stock market and has written more than 1,200 articles on investing. As of this writing, he did not hold a position in any of the aforementioned securities. He can be reached at TheLibertyPortfolio@gmail.com.
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