There’s something intriguing about companies that have stood the test of time. Many popular growth companies today won’t survive the next bear market when equity or debt capital becomes scarce. But a company like Pfizer (NYSE:PFE), which was founded in 1849, has not only survived through two World Wars but also the American Civil War. It has survived approximately 35 recessions or depressions since its founding. Of course, though, it’s also likely that PFE stock has never caught the same attention it has today over its 170-year history.
Pfizer is hot right now because, in conjunction with Biontech (NASDAQ:(BNTX)), it created one of the first Covid-19 vaccines, which was first authorized in December. According to the company, that vaccine alone may bring in $15 billion, which is on top of their core $45 billion in annual revenues.
What’s more, Pfizer expects to deliver 200 million doses globally by May and possibly 2 billion by the end of 2021. Plus, that $15 billion in revenues is just based on low initial pricing per shot. Normalized pricing may be three to four times the initial cost of $19.50 per dose.
Really, Pfizer has been transforming itself into a pure pharmaceutical and biotech company for a while now.
In 2019, for instance, PFE merged its remaining consumer healthcare business into a joint-venture with GlaxoSmithKline (NYSE:GSK). Pfizer owns 32% of the new company. This has allowed the core Pfizer to grow more rapidly without the slow-growth consumer business. Operational revenue growth excluding the Covid-19 vaccine was up 8% in 2020 and is expected to be up 6% in 2021. Not bad for a 170-year-old name.
That said, pharmaceutical patent expirations are a common nuisance for these types of companies and often produce lumpy results. A drug approved by the U.S. Food and Drug Administration (FDA) usually receives a 20-year patent in which no competitor can reproduce the exact formula.
After patent expiration, generic drug companies jump in and produce identical drugs at much lower costs to the public. To that end, a large patent expiration cycle is expected in 2026 for Pfizer.
However, there are three answers that could counter the potential crisis of patent expiration here — pipeline, pipeline and pipeline. Pfizer has a deep bench of potential drugs that may come to market in the next five years. They could potentially fill the patent-expiration gap. That bodes well for PFE stock.
Financial Strength Is Usually Not a Problem for PFE
Another reason to like Pfizer is its financial strength.
High margins and large levels of free cash flow are common place for pharma companies, as they need to recoup the billions spent on research and drug development which often takes many years. At year-end 2020, PFE carried over $12 billion in cash and short-term investments as well as $20.2 billion in equity-method and other long-term investments. Total debt stood at $40 billion, but with $13.5 billion in EBITDA in 2020 and maybe $25 billion expected in 2021, PFE’s debt ratios are investment grade.
If capital expenditures are ramped up to over $3 billion, that leaves $20 billion in free cash flow based on estimates. The dividend will eat up almost $9 billion of that, leaving around $11 billion for debt repayment, stock buybacks or acquisitions. Keep in mind, this is after already spending $10 billion on research and development.
Pfizer has also paid a dividend for many decades. Currently, the dividend stands at $1.56 per share, which equates to a 4.34% dividend yield. With maybe $20 billion in free cash flow, the $9 billion annual dividend payment appears to be well covered. So, although adjustments can always be made — particularly considering potential Covid-19 vaccine drop-offs or future patent expirations — one can expect an above market average dividend yield for PFE stock going forward.
When it comes to Pfizer, a steady state operating income or EBITDA growth rate in the 6% to 8% range would produce a fair value in the low $50s, according to my discounted cash flow (DCF) valuation. However, this becomes a little complicated due to the potential drop-off in Covid-19 vaccination revenues (at least $15 billion in 2021). Potentially, 2022 could see a double-digit decline in revenues if Covid-19 vaccinations become a one-time thing.
But, what if vaccinations occur every year, like a flu shot? After the potential price increases mentioned above, this could be a material positive outcome on revenues and margins. Plugging those type of numbers into my DCF calculations, PFE stock could be worth in the low $70s in the next several years.
PFE stock trades at around a 10 to 11 times cash P/E ratio currently (I add back amortization to get cash earnings). Yes, it probably won’t trade at the S&P 500’s multiple anytime soon, but reaching a mid-teens multiple combined with a 4% dividend creates a great investment opportunity at this time.
Bottom line? Consider a position in PFE stock.
On the date of publication Tom Kerr did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Kerr, CFA is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.