6/6/08

Pfizer: How Low Will It Go?

I wrote about wanting to buy some shares of Pfizer (PFE) a while ago. I thought a good entry price would be under $20 a share. Well, the stock has been falling. It hit a new 52 week low today, at the time of writing $18 a share.

The reason for the steady decline? As mentioned in that earlier post, Pfizer faces patent expirations on many of its drugs. The drug maker has already lost patents on Norvasc and Zyrtec. The patent on Lipitor, which accounted for 40% of 2007 profits, and around 26% of 2007 sales, will expire by 2011, along with a number of Pfizer's other drugs, accounting for roughly half of its US drug sales.

Lipitor's sales are dwindling already, as makers of generic drugs are putting copies of Merck's (MRK) Zocor on the market. After the patent expires, generic copies of Lipitor will flood the market.

There are new drugs for Pfizer. Three in particular have sales growing at double digit rates. These are Lyrica (nerve pain), Sutent (cancer), and Chantix (smoking). Sales from these drugs, however, are only partially offsetting losses. In the most recent quarter, sales fell by 5% year over year. This includes the foreign exchange rate from international sales, which boosted revenues by 5%. Moreover, there are some safety fears associated with Sutent and Chantix that could potentially slow sales or remove the drugs from the market.

More bad news? The big fat dividend, currently yielding around 6.8%, could be cut. Last year, Pfizer paid out $8 billion in dividends. While the company has about $25 billion in short term investments and cash, most of this money is overseas. Dividends must be paid from its US coffers. To move the overseas money to the US, Pfizer will incur a massive tax hit, says David Risinger of Merrill Lynch, making such a move unwise and unlikely. So far, the company says the dividend is safe, and hints at plans to raise it. Pfizer projects the dividend will soon yield around 10%. At the same time, the Pfizer board is said to be worried that if the dividend is cut, the stock will fall to $10 or $12 a share.

It seems strange to me that Pfizer's directors can think about raising the dividend while at the same time thinking that it cannot be sustained at current levels. If directors are confused on such a basic topic as dividends, no wonder investors are dumping shares.

Add to this a seemingly lackluster drug pipeline. There's little indication of promising new drugs on the horizon.

Now, when everyone else is fearful and there seems little good news on the horizon, it might be the time to start picking up some shares. This is how contrarian investors make a lot of money. Reasons to buy now or soon would be trust in Pfizer's management to effectively cut costs, make acquisitions or strategic partnerships to increase sales, and hire the talent needed to develop new blockbuster drugs. Will any of these things happen? Well, it's the same management team that brought us to this point. Another reason to buy would be a gamble that current management will be replaced by a more competent team. None of these seem very good. Perhaps the best reason to buy now would be a bet that drugs now in Phase I and II trials will at some point in the future be as successful as Lipitor was. This is certainly possible, but it's hard to determine at this point.

Another reason to buy can be the hope that Pfizer manages to buy out--whether through joint ventures, some sort of licensing schemes, or just brute acquisition--for a reasonable price, those generic drug companies that will sell generic versions of Pfizer's drugs whose patents are expiring. For example, Pfizer might make a bid for Ranbaxy Labs, an Indian company that will make generic Lipitor. Ranbaxy has a market cap of around $4 billion. It seems Pfizer could easily buy it out. But what would stop some other generic company from making Lipitor? Pfizer can't buy them all, can it?

Goldman Sachs downgraded the stock recently, cutting its target price to $22 a share. While a cut, that's over 20% of today's price. I guess the market doesn't agree. Pfizer currently trades at less than 8 times projected 2009 earnings.

I'm one of those too fearful to buy right now. I'll see what happens to the dividend and if the stock does fall to $10 to $12 a share. The danger of a dividend cut seems to have pulled out the price floor from Pfizer's feet. Unless there's a dividend raise (which I think would make poor financial sense), the stock price will probably continue to drift lower.

Update on recent developments here.



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