Even though President Trump set his sights on Pfizer (NYSE:PFE) after the company announced it would hike drug prices, PFE stock continued to trade on the higher end of its trading range. At a share price of just 5% percent below yearly highs, should investors consider adding to or starting a position in this drug manufacturer?
President Trump tweeted his criticism on Pfizer’s price hike on Jul. 9, writing:
“Pfizer & others should be ashamed that they have raised drug prices for no reason. They are merely taking advantage of the poor & others unable to defend themselves, while at the same time giving bargain basement prices to other countries in Europe & elsewhere. We will respond!”
Drug companies are having a tough time pushing through drug price hikes. At the height of the U.S. presidential election, politicians took aim at pharmaceuticals, criticizing their pricing model. Competition will heat up in the years ahead as the FDA relaxes its review cycle and encourages generic suppliers to develop cheaper alternatives.
To offset the profit margin deterioration, Pfizer and others may think raising prices will quickly fix the problem. Take Viagra as an example. One pill costs around $70 in a 100mg dosage, so 10 pills cost $700. On Jan. 1, 2017, the pill had cost around $55. This makes the nearly 30% increase far exceed the rate of inflation.
Pfizer may rely on rebates to secure reimbursement deals it has with health insurers. So, the company will not necessarily benefit from raising profits through a hike in retail prices.
Upcoming Headwinds
Pfizer has a number of drugs falling under an LOE, or loss of exclusivity. Sterile injectables, Lyrica and Enbrel will all face LOE, lowering Pfizer’s revenue by billions.
In 2017, Lyrica, which treats such diseases as epilepsy and neuropathic pain, amounted to 10% of the company’s 2017 sales. Sales of Enbrel, which treats psoriasis and arthritis, continue to decline. In 2015, sales totaled $3.33 billion, but by 2017, sales dropped to $2.45 billion.
Growth Catalysts
A drug company typically offsets lower sales due to LOE by discovering new drugs and bringing them to market.
For example, Regeneron (NASDAQ:REGN) is working on other indications for its Dupixent drug. AbbVie (NYSE:ABBV) has a broad array of products in the pipeline. This includes a once-a-day oral drug that treats atopic dermatitis, a market that is worth billions in annual revenue.
Celgene (NASDAQ:CELG) took a different approach as it acquired Juno Therapeutics for $9 billion.
Unfortunately for shareholders, Pfizer’s growth will come from acquisitions. This could hurt investors in much the same way Celgene’s Juno buyout caused its stock to fall.
The big buyouts cost billions if it is a blockbuster deal. The acquirer takes on lots of debt, and with the deal, all the risk. If Pfizer’s future acquisitions work out, they will contribute meaningfully to profits and act as a catalyst for growth. But if the acquired company fails to produce a blockbuster drug, or worse, the clinical study flunks, then Pfizer would have to write off the loss.
Valuation for PFE Stock
Analysts are somewhat bullish on Pfizer. The current 12-month price target on PFE stock is $40.75, implying the stock has upside of around 10%. More recently, BMO Capital’s Alex Arfaei called Pfizer stock a “Buy” with a $42 target. The analyst is successful 73 percent of the time and has an average return of 7.6 percent over a two-year period.
Both the DCF Growth Exit and EBITDA Exit models suggest Pfizer could have a fair value in the $50 range. To earn that almost-35% upside, Pfizer cannot miss a single year in growing revenue in the single digits for the next 10 years. EBITDA margin must also stay over 40%.
Takeaway on PFE Stock
Pfizer could sustain its historical earnings growth if it invests carefully and manages to raise prices in some of its drug products. Yet with the government watching out for biotech stocks hiking prices too much, Pfizer does not have lots of room to lift profits through price hikes.
Disclosure: The author does not own shares in any of the companies mentioned
