If you were to ask most investors what the most dominant sector is in the S&P 500, many would (correctly) answer technology.
Interestingly, some would be surprised to discover that healthcare is the second-heaviest weighting within this index of large-cap equities. Indeed, blue-chip healthcare companies are very prevalent within the S&P 500.
Pfizer (PFE) is one such example. The company was founded in 1849, trades with a market capitalization of $217 billion and a dividend yield of 3.7%, and has paid eight years of rising dividends to shareholders.
In this article, we'll investigate Pfizer's business model, financial performance, and growth prospects to determine whether the company is worth investing in today.
Pfizer is one of the world's largest and most distinguished pharmaceutical companies. The company researches and manufactures drugs for a variety of therapeutic arenas.
The company is divided into two segments for the purchase of reporting financial results:
- Innovative Health - comprising approximately 60% of company-wide revenue
- Essential Health - comprising approximately 40% of company-wide revenue
Pfizer's most important therapeutic areas are internal medicine, oncology, immunology, inflammation, and rare diseases.
Recent Financial Performance & Current EventsIn early May, Pfizer reported (5/1/18) financial results for the first quarter of 2018. The company generated revenue of $12.91 billion, which rose by 1% over last year's comparable quarter but missed expectations by $240 million.
On the bottom line, cost-cutting and share repurchases helped the company to perform far better. Pfizer generated adjusted earnings per share of $0.77, which beat analyst expectations by $0.02 and rose by 12% over the year-ago reporting period. Overall, it was a solid earnings release, with performance primarily driven by the company's Innovative Health segment (which grew revenue by 6% in the reporting period).
More recently, Pfizer announced (7/11/18) a modest corporate reorganization. More specifically, Pfizer will change its reporting structure to be divided into the following three segments:
1. Innovative Medicines
2. Established Medicines
3. Consumer Healthcare
These changes are to begin with the commencement of Pfizer's 2019 fiscal year. While they are not a material change for the company as a going concern, continuing investors should make themselves familiar with this announcement to avoid confusion when analyzing future earnings releases.
For a large-cap biopharmaceutical company such as Pfizer, the main source of future growth is the company's drug pipeline. The company has received 22 key drug approvals since 2011, which helps to offset near-term patent expirations.
More importantly, future progress on Pfizer's pipeline should be even better. Pfizer has stated that it believes it can achieve as many as 30 product approvals over the next five years. The oncology pipeline is particularly interesting. Pfizer has 13 oncology drugs in Phase I, 4 in Phase II, and 6 in Phase III.
Pfizer's pipeline is the result of deliberate research & development budgeting. The company spent at least $7.6 billion on R&D during each of the last three fiscal years and expects to invest another $7.4 billion to $7.9 billion in fiscal 2018. We expect Pfizer to continue to aggressively invest in research and development moving forward.
Separately, Pfizer has also driven growth through acquisitions. Its two biggest deals of late were the $17 billion acquisition of Hospira and the $14 billion acquisition of Medivation. Because of acquisitions and the company's existing drug pipeline, we believe that Pfizer should be capable of delivering mid-single-digit earnings-per-share growth over full economic cycles.
Valuation & Expected Total Returns
One of the most interesting components of Pfizer's current investment thesis is the company's valuation. To put it simply, Pfizer appears to be trading at a meaningful discount to its normal valuation levels.
Here are what the numbers look like. Pfizer is expected to generate earnings per share of around $2.95 in 2018. Given the company's current stock price, this implies a price-to-earnings ratio of approximately 12.6. Pfizer has traded at an average price-to-earnings ratio of around 17 over the last decade. Accordingly, we believe that valuation expansion should have a significant positive impact on the company's total returns moving forward.
In addition, Pfizer should be capable of generating mid-single-digit earnings-per-share growth, as we discussed previously. Putting this together with the company's current dividend yield of 3.7%, and we believe the company has double-digit total return potential at its current price.
Importantly, Pfizer is likely to deliver these returns with much less risk. The company is a relatively low-risk stock -- especially relative to its peers within the biopharmaceutical space. The company's size and diversification mean that it is not dependent on any one drug to generate revenue. Moreover, the company has a conservatively positioned balance sheet. Just over half of its assets are debt-financed, which is reasonable for a company with such a predictable business model. Lastly, Pfizer's competitive advantages (which come in the form of a diverse and complex web of drug-related intellectual property) should provide an economic moat that allows the company to continue growing for the foreseeable future.
Pfizer has many of the characteristics of a high-quality business. The company was founded more than a century ago and has paid rising dividends to shareholders for several years. Pfizer's dividend yield of 3.7% is also roughly twice the average dividend yield within the S&P 500.
In addition, Pfizer is trading at a noticeable discount to its historical valuation multiple. There is a good chance that valuation expansion will meaningfully benefit shareholders who purchase today.
For these reasons, we are recommending this stock as a buy today.