Detailed Case Study of Pfizer Inc
Currently, Pfizer Inc. has three major core business segments. First, Pfizer’s pharmaceutical segment provides treatments for cardiovascular and metabolic diseases, central nervous system disorders, arthritis and pain, cancer, eye disease, etc. In 2003, over 1 billion prescriptions were written for Pfizer medicines. In addition, 14 of their prescription drugs were category leaders in 2003. Some of Pfizer’s most noteworthy drugs are the allergy medication Zyrtrec, the erectile dysfunction drug, Viagra, and Celebrex which helps painful arthritis. Next, Pfizer’s Consumer Healthcare segment includes many over the counter health care products. These medications include self-medications for oral care, respiratory health, skin care, hair growth, tobacco dependence, etc. This segment produces many of the well-known brands such as Visine, BenGay, Listerine, Benadryl, and Sudafed. Finally, Pfizer’s Animal Health segment is mainly responsible for treatments for disease in livestock and domestic animals. Pfizer’s animal heath business is the largest in the world2.
INDUSTRY/ COMPETITVE ENVIRONMENT
The Pharmaceutical Industry has been under some serious pressure in recent years. Many of the legitimate concerns involve patent expirations, generic competition, drug importation, and legal liabilities. There is particular controversy over the drug companies of Merck and Pfizer. In late 2004, Merck pulled Vioxx from the market, after discovering that the drug could augment the risk of cardiovascular disease. Since this time, Merck has lost over 30 billion in market valuation. In addition, Pfizer’s stock price also reflected decreased significantly because of the drug Celebrex. Studies conducted by the National Cancer Institute showed that the drug raised the risk of heart attacks and stocks. Since the Vioxx and Celebrex controversies, investors have been reluctant to invest in other drugmakers in the fear of similar situations. However, many research companies view that people have overreacted to the Merck and Pfizer controversies3.
The US leads the world in the purchase of drugs. In addition, it serves as the home for five of the ten largest drug producers: Bristol-Myers Squibb, Johnson and Johnson, Merck & Co., Pfizer, and Abbot Laboratories. After the purchase of Pharmacia, Pfizer firmly established their mark as the world’s largest drug company. Pfizer has 14 drugs that are the top sellers in their respective categories. Currently, drug companies are focusing on drugs that require chronic consumption in order to maintain a steady client base. A promising figure for the drug industry is that the world’s elderly population is increasing. On average, this group consumes three times and as many drugs and the younger populations. However, the aging population has increased the need for cheaper drugs. In addition, many of drug companies patents are expiring. Many drug companies are paying generic drug companies to not produce their drugs. This is enticing many of the major companies to merge with smaller companies. Experts insist that more companies will be merging in order to save money and find the next blockbuster drug4.
RATIO ANALYSIS (all ratios in APPENDIX II pgs 1-8)
In 2003, Pfizer’s current ratio, a measure of liquidity, was 1.2572. The current ratio is calculated by dividing the firm’s current assets/current liabilities. Thus, the current ratio is useful in assessing the company’s ability to pay short-term obligations. In addition, the current ratio is useful for comparing companies of the same industry5. For the pharmaceutical industry in 2003, the current ratio was 1.8921 which means Pfizer is slightly less liquid then the average company in the drug industry. The higher the current ratio, the less likely the company is to default on its current obligations. Although Pfizer’s current ratio is below the average the its industry bond raters have historically rated Pfizer’s debt with extremely high ratings, “Fitch Ratings has assigned ratings of ‘AAA’ to Pfizer’s Inc.’s senior unsecured debt and ‘F1’ to the company’s short term debt.”6 This article in Business Wire continues to explain why the ratings are so high “Pfizer’s ratings reflect its superior liquidity and cash flow generation. At the end of the first quarter 2004, the company had approximately 14 billion of cash in addition to 5.4 billion of long term investments.”6 Thus, as long as Pfizer maintains a current ratio that is greater than one (current assets are greater than current liabilities), it appears to be a positive sign for the company. A low current ratio can indicate that the company is operating efficiently and they are not tying up funds in current assets rather than taking advantage of higher yield, longer-term financial opportunities5.
Next, an important ratio when dealing with the concept of efficiency is the sales to total assets ratio. To compute sales to total assets you divide Pfizer’s sales to total assets was .38697 in 2003. In contrast to the drug industry, the mean sales to total assets was .5744. Basically, this means that Pfizer’s competitors are producing their products much more efficiently7. However, this number may be skewed because of Pfizer’s large expenditure on Research and Development. In 2004, Pfizer spent approximately 7.7 billion in R&D, the greatest amount in the pharmaceutical industry2. Thus, Pfizer’s low sale to total assets indicates that the company has a lot of room for improvement in regards to efficiency.
Another important ratio when assessing Pfizer is the leverage of the firm demonstrated in the debt ratio. The debt ratio is calculated by adding short-term and long-term debt and dividing by total assets5. Pfizer has a debt ratio of .2519 compared to the drug’s industry average of .39014. The fact that Pfizer has a below average total debt to assets ratio relative to its industry indicates that the firm is less risky than the average drug industry firm. In addition, it also indicates that Pfizer can lower its cost of capital if more debt is used in financing because financing with debt cost less than financing with stock5.
Instead of examining the return on equity of Pfizer individually, it is easier to incorporate the ROE with the analysis of the Dupont Ratio. The Dupont ratio is calculated by the following formula8�
Profit Margin X Total Asset Turnover X Equity Multiplier =Dupont equation
*profit margin= net income/sales *asset turnover= sales/total assets
*equity multiplier=total assets/equity
Pfizer’s Dupont Ratio for 2003 was .02304 while the industry Dupont Ratio was .162. Therefore, this also shows that Pfizer’s Return on Equity Ratio was also much lower than the industry. Thus, this indicates that Pfizer currently has weak operating management (low profit margin), weak asset management (low asset turnover), and also a weak capital structure9. This weak capital structure was also demonstrated in Pfizer’s relatively low total debt to asset ratio. This could be a sign that Pfizer needs to change its capital structure.
Finally, the New Z model is useful to identify firms that are struggling or near bankruptcy. The New Z score uses current and past profitability, liquidity, leverage, and sales turnover ratios to calculate a single score. If a firm’s new Z is greater than 2, it is considered financially healthy. If a firm’s New Z is less than 2, the firm is considered to be struggling7. Pfizer’s New Z score was approximately 2.024 which means the companies current financial situation is relatively stable. The industries New Z is slightly higher than Pfizer’s at 2.288. However, this difference real is not that significant and Pfizer Inc. is still considered a relatively safe stock compared to other stocks in the pharmaceutical industry.
Stock Valuation (all work is shown in APPENDIX V pgs 1-2)
First, we must find Pfizer’s required rate of return. In order to find the required rate of return we use the following equation.
K=Rf + {E(Rm)- Rf}*B
*Rf=the current federal funds rate9 = 2.75%
*E(Rm)=11.85% (for large stocks)10
The beta (B) for Pfizer is .3847 and was found by running the SAS Program. The beta’s standard error is .17953 and t value is 2.14 (APPENDIX I). Beta is calculated using regression analysis. A beta of 1 indicates that the security’s price will move with the market. A beta greater than 1 indicates that the security’s price will be more volatile than the market. A beta less than 1 means that it will be less volatile than the market5. Therefore, Pfizer’s stock is considered a relatively low risk investment. We know that Pfizer’s Beta is valid because of the t-value when the data was run. The t-value is 2.14 and therefore, we reject the null hypothesis that beta is equal to zero because Pfizer’s beta is not in the range between {-2,2}12. Thus, we are 95% confident that Pfizer’s beta is not equal to zero and that the SAS Program data is valid.
If we substitute the above values into the Capital Asset Pricing Model above, we find that�.
K= 2.75% + (11.85%-2.75%)*.3847
We find that Pfizer’s required rate of return is approximately 6.25%.
Dividend Growth Model (all work is shown in APPENDIX V pgs 1-2)
In order to find the fundamental value of Pfizer’s stock, we use the dividend growth model.
Pcs= D/K-G
Hoovers online an investment website stationed out of New York City found that the forecasted dividend growth rate for Pfizer was 16.1%13. Therefore, we must assume that this is a supernormal growth rate and we must apply the supernormal growth rate model.
First, we must find the future dividends and the periods of supernormal growth. Next, these dividends must be discounted at the Pfizer’s required rate of return which is 6.25%.
By adding the present value of these future dividends we find the present value of the first 5 years of dividends is $3.95. Next, we need to evaluate the value of years 6 and on assuming the historic growth rate of the economy of 4%. We use the following equation�
Pn=Pn+1/K-G = D5 (1.04)/.0625-.04
We find that the future value of dividends at year 5 is equal to $58.4. We discount $58.4 at Pfizer’s required rate of return to find Pn discounted to today= 43.20. Thus, we find the price of Pfizer’s common stock is equal to $43.20+$3.95= $47.15. Pfizer’s current stock price is approximately $27.00. Thus, using the Gordon model with a supernormal growth rate of about 16% for five years we find that Pfizer’s stock is equal to 47.15 and undervalued by nearly twenty dollars.
In order to check the validity of Hoover’s investment website, we decided to calculate Pfizer’s historic dividend growth rate in the previous ten years. Pfizer’s current dividend is $.60. Ten years ago Pfizer’s dividend was $.14 . Therefore, we find the historic growth rate of the previous ten years by the following equationâÂ?¦
g= .60/.14 – 1
We find that the growth rate in the previous ten years is approximately 15.57%. We can conclude that Hoover’s Investments Online forecasted dividend growth rate can be substantiated and could be considered valid. Therefore, Pfizer’s value of common stock of $47.15 is considered a legitimate fundamental value.
CONCLUSION
Some investors may need more than the stock evaluation shown above to be convinced to purchase Pfizer’s stock. Therefore, Pfizer should be bought for many other reasons besides the significant current under valuation of their stock price.
First, Pfizer’s 2004 performance speaks for itself. In 2004, total revenues increased 17% to 52.5 billion and 39% to 44.7 billion in 2003. Also, the company’s net income increased to 11.4 billion in 2004 compared to a mere 3.9 billion in 2003. In addition, Pfizer achieved cost synergies from the Pharmacia acquisition of 3.6 billion in 2004, up from an annual rate of 1.3 billion in 2003. In addition, despite some negative publicity with the drug Celebrex, Pfizer has consistently increased their dividends in the last 10 years14.
Next, most respectable investment sources recommend buying Pfizer stock. These sources adamantly proclaim that Pfizer is a solid company. Morningstar, a reliable source of independent research and data gave Pfizer a premium rating and stated “Pfizer has a impressive branded drug portfolio and best-in-class sales force.”15 In addition, Forbes Magazine sights the past high stock prices of Pfizer and an investment analysis stated ” I believe that return will occur this year, especially in the second half of this year as the rotation to quality, industry leading stocks accelerates.”16 Also, Value Line also gives Pfizer very favorable reviews. The financial strength of the company was given an “A++”, the stock price stability is a 90 out of 100, and the earnings predictability was given a perfect score of 100 (Appendix III). The earnings predictability is significant because this means that Pfizer is a relatively non-volatile company and this implies that forecasted growth rates are usually very reliable for Pfizer. Thus, this supports the reliability of the supernormal growth rate used in our model.
Finally, investors must put the numbers aside and think logically about the true value of Pfizer’s stock and company. Pfizer’s stock price plummeted when investors found out about the possible negative effects of Celebrex. However this drug only accounts for 6% of the company’s total sales. Investors must keep in mind that Pfizer has fourteen drugs that are at the top of the respective categories. In addition, it should be noted that Pfizer has more than 160 projects in development and more than 300 projects in discovery research2. The R&D of Pfizer is unmatched in the industry. They have significantly increased their spending each year and are constantly coming up with new drugs. Furthermore, the elderly population is increasing. People are simply living longer and this means that people are going to be consuming more and more drugs.
It makes sense in all areas: logically, financially, and mathematically. Pfizer’s stock should be an immediate BUY.
Bibliography
1. http://en.wilkipedia.org (Pfizer Inc. History)
2. www.pfizer.com
3. Value Line 2004 Drug Industry
4. http://finance.yahoo.com (Industry Center-Major Drugs)
5. www.investopedia.com
6. Business Wire, “Fitch Rates Pfizer, Inc. “AAA”: Rating Outlook Stable. June 30, 2004.
7. Chapter 5, Guerard and Schwartz, QCF. Kluwer Academic Publishers, 2005
8. Dr. Chris Peterson, “Dupont Analysis and Its Interpretation”
9. www.msu.edu/course/abm/437/lectureDupontAnalysis.pdf.
10. www.bloomberg.com
11. Ibbottson and Sinqurfield Data, 1926-2003
12. www.statistics.com
13. www.hoovers.com
14. Pfizer Inc and Subsidiary Companies: Financial Review
15. www.morningstar.com
16. www.forbes.com
