The dividend is really important to me. The company feels they can keep it up through the patent expirations, but it seems like it’s going to be difficult.
– Kent Croft (subscription required), President, Croft Leominster
There’s been a lot of talk and action regarding Pfizer (PFE) since a Wall Street Journal article last Tuesday questioned whether it might have to cut its attractive 7% dividend: “Dividend May Test Pfizer: Company’s Funding Of Generous Payout Could Face Hurdles” (subscription required).
On Thursday, Goldman Sachs cut Pfizer from Buy to Hold and removed it from its Americas Conviction List (“Two To Watch In Big Pharma” (subscription required)).
As a result, the stock is down more than 11% in just the last 3 weeks (PFE YTD Chart).
While there are a lot of legitimate concerns regarding Pfizer’s business and stock, I think the stock is starting to look attractive at these levels.
Let’s start with the legitimate concerns.
First off, the dividend consumes most of Pfizer’s cash flow. It will cost Pfizer about $8.7 billion this year to pay its $1.28 annual dividend on its 6.76 billion outstanding shares. Pfizer generated $13.3 billion in free cash flow over the last 4 quarters, so it can pay the dividend out of cash it is generating – but that consumes most of its cash flow.
Second, while Pfizer has a ton of money on its balance sheet ($28.6 billion in cash and short term investments as of March 31, 2008), a lot of this cash is held outside of the US and would require repatriating which would result in taxes in order to be used to pay the dividend. So this is a worrisome issue. How much of that cash on their balance sheet is really available to be used as desired, for example to pay out the dividend if necesary?
Third, Pfizer’s key drug, cholesterol drug Lipitor, which accounted for about a quarter of Pfizer’s sales over the last 4 quarters and 65% of its cash flow according to Credit Suisse Pharmaceuticals analyst Catherine Arnold, goes off patent protection in 2010. That’s a huge worry.
Finally, Pfizer’s pipeline and current portfolio doesn’t seem to have any blockbusters that can make up the shortfall when Lipitor goes off patent protection. In other words, it doesn’t seem like Pfizer will be able to maintain current levels of revenues, earnings and cash flow once Lipitor goes off patent protection in 2 years.
So these are some pretty significant and legitimate concerns.
On the other hand, the valuation is starting to become compelling. Pfizer has about $16 billion in net cash and investments on its balance sheet (once you back out the debt). It is now trading for about 7 times enterprise value (market cap – net debt) last 4 quarters net income and 8 times last 4 quarters free cash flow. That’s cheap.
The 7% dividend is probably sustainable for at least the next 2 years and so that is also an incentive to hold, at least for a while. Even if Lipitor generates half of Pfizer’s cash flow and that gets cut in half in 2010, 2011, we’re still looking at a 10 times multiple on free cash flow – still cheap.
I’m not going to lie: I’m a little scared to be holding Pfizer here. But sometimes that’s a sign of a good investment.
Disclosure: Top Gun is long Pfizer (PFE) shares.