Business Description:
Pfizer is a well diversified pharmaceutical company with $51.7 billion in revenues in 2019. 46% of these revenues came from the US, 9% from China, 8% from Japan and 37% from the rest of the world. The biggest customers of Pfizer include McKesson (16% of revenues), AmerisourceBergen (12%) and Cardinal Health (10%) with 32% of US sales coming from McKesson. The top five best selling drugs in 2019 were the following: Prevnar 13 ($5.8 billion), Ibrance ($4.9 billion), Eliquis ($4.2 billion), Lyrica ($3.3 billion), Xeljanz ($2.2 billion). Lyrica is one of those drugs which is in the portfolio of Upjohn as the US patent on the drug expired in June 2019. According to Pfizer, in 2019, $2.2 billion in revenues would be impacted because of the patent expiration on Lyrica.
Following the spinoff of Upjohn, Pfizer is only going to focus on the following businesses and key drugs below:
And here are the patent expiration dates of these drugs:
Important to note that the US patents on their three best selling drugs all expire before 2027 with Ibrance expiring in 2023.
Catalyst:
There are two main catalysts that are going to change the business of Pfizer in the coming years, the spinoff and the Covid-19 Vaccine. The spinoff is certainly going to improve the efficiency and margins of the company. The pro forma revenues and profits of the new Pfizer are going to be lower in the beginning but if they can keep making new patented drugs, it should bring more free cash flow to the company over the long-term until they face the same challenges again, the expiration of these patents.
As for the second catalyst, the vaccine, it was unexpected. Wall Street was more bullish on competitors such as Moderna, Astra-Zeneca, and Johnson & Johnson. Pfizer did not even receive any investment from the US Federal Government for the development of this vaccine. The vaccine has been made in partnership with the German company Biontech. With 43 538 participants in the Phase 3 trials, a vaccine with 90% effectiveness has been made. Pfizer has all the necessary logistics to mass produce the vaccine and plan to produce up to 1.3 billion doses in 2021.
So far, Pfizer got a 100 million doses preorder worth $1.95 billion from the US Government with the option of buying another 500 million doses. The cost of one dose would be $19.50. The EU pre ordered 300 million doses at a lower (closer to $20 than $10) but undisclosed price. In total, around 600 million doses have already been pre ordered with Pfizer estimating 1.3 billion orders to come in total in 2021 with 100 million doses to be produced by the end of 2020.
Assuming a price of $19.50 per dose, Pfizer could potentially increase their revenues by $11 billion to $25 billion in the coming 13 months. Since we already know that the $19.50 price will be lowered, we will have to take a margin of safety in the free cash flow calculations. In the last 10 years, the FCF margin of Pfizer ranged from 20%-30%. With the urgency to deliver this vaccine at a fast rate, the high competition, and our margin of safety, let’s assume a margin of 15% on the vaccine. Therefore, the extra FCF generated by the vaccine in 2021 (including December 2020) should be as follows:
Bull case: +$3.75 billion
Bear Case: +$1.75 billion
Base case: +$2.5 billion,
with half these numbers in 2022.
Financial Analysis:
In the past 10 years, Pfizer saw a 25% fall in revenues with operating income, net income and free cash flow pretty volatile but not making any progress or regress over the long-term. The revenues will take a 20% hit in the coming years because of the spin off but this can be countered by the revenues from the vaccine. Over the long-term, however, revenues and consequently FCF is unlikely to grow by much. EPS did better than the other metrics as the company bought back 30% of shares outstanding in the period.
As for the balance sheet, in the last 10 years, the assets of the company declined by about 8% with an increase in liabilities of 6%. The book value fell by 25%. It is important to note that 84% of the total assets of the company is in intangibles and goodwill. Consequently, Pfizer has a negative tangible book value of $26 billion. The total assets are $179 billion, total liabilities $113 billion and book value $65.2 billion. The current assets of Pfizer are $47.7 billion, including $1.58 billion in cash and cash equivalents and about $8 billion in marketable securities. The total liabilities of the company are $34.1 billion. Pfizer has a huge debt of $61.5 billion with most of the maturities after 2025.
The debt can be a problem since Pfizer has to repay the interest and as they mature, pay the principle. In 2019, Pfizer repaid $22 billion of debts, bought back $8 billion worth of shares (the share repurchase program is currently on pause) and paid $8 billion in dividends. The company had only $10 billion in FCF.
The current dividend yield is 3.95% with a buyback yield of about 4% last year. This can only be financed by debt and it is unlikely that Pfizer will be able to maintain these without the debt getting out of control.
Valuation:
We are going to find the intrinsic value of Pfizer based on the discounted FCF method. In the last 3 years, the average FCF of Pfizer was $11.3 billion per year. With the spinoff, let’s assume that the proforma FCF would be about $9 billion. This is not 100% accurate since it is clear that the proforma company will have improved margins but we’re taking a margin of safety for the first few years.
We already saw the extra FCF which will be generated by the vaccine in 2021 and 2022.
Bull case: +$3.75 billion in 2021 and +$1.88 billion in 2022
Bear Case: +$1.75 billion and +$0.88 billion
Base case: +$2.5 billion and +$1.25 billion.
Since the margins of the company will be improving, we will assume eventually the company to have $10 billion in FCF in 2023 with a perpetual growth rate of 2%.
The discount rate we’re going to use will be 15%. We have to use this high number because of the big debt.
The intrinsic value of Pfizer is about $80 billion in our bull case. The market cap of Pfizer is $214 billion with an enterprise value of $266 billion. I don’t think we need to go further. Pfizer is expensive according to our calculation.
Normally, we would look at different scenarios with different exit multiples but here I don’t think it is worth our time. The current PE ratio of Pfizer is 24 and the Price to FCF ratio is also around 24, which is already pretty expensive for a stock which underperformed the Healthcare Sector, the Pharmaceutical Industry, the general market and its leading competitor Johnson & Johnson in the last 10 years.
Conclusion
There are two important things happening to Pfizer in the short term, the Covid-19 Vaccine and the Spinoff of Upjohn. The vaccine will increase sales and FCF in the coming two years. As for the spinoff, it will lower revenues but improve margins. Both events, however, are only temporary. In the long-term, Pfizer still faces many challenges, such as dealing with its debts and growing organically.
Since Pfizer is already paying a nice dividend and the business is pretty safe, I will give Pfizer a Hold rating but high returns shall not be expected on this stock.
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