Shares of Pfizer (NYSE: PFE ) have fallen more than 20% so far this year, excluding its dividend. But just because its shares are down, don't assume the bleeding is over.
There are two very important questions that every Pfizer investor or potential investor needs to ask themselves. One: Is the company’s dividend sustainable? And two: What can it do to make up for the more than $17.7 billion worth of its compounds that will be facing increased generic competition by the end of 2012? The answers to these questions will be crucial in determining whether Pfizer shares are cheap enough today, or whether investors should wait to buy shares.
About that dividend
Last year, Pfizer spent nearly $8 billion of its $11.5 billion in free cash flow (nearly 70%) on dividend payments to shareholders. Although there is some lumpiness to operating figures like free cash flow, in the first quarter of this year -- even before the next wave of upcoming losses of exclusivity on its top drugs -- the portion of free cash flow that it has paid out in dividends has already climbed to more than 76%.
This ratio is important, because free cash flow funds these dividend payments. In the coming years, as Pfizer’s top line takes several hits from drugs losing their marketing exclusivity, this FCF figure will be significantly reduced. Even if Pfizer is able to use some of the cash it has stashed away on its balance sheet for a large acquisition, it'll likely only be partially able to plug its upcoming revenue hole.
Sustaining the dividend isn't the only problem
I’ve been a Pfizer bear for some time now, for many reasons. Perhaps the No. 1 portfolio killer is underestimation of risk, and Pfizer still has multiple risks and uncertainties not fully accounted for in its share price.
Consider the weakness of Pfizer’s pipeline relative to peers like GlaxoSmithKline (NYSE: GSK ) and AstraZeneca (NYSE: AZN ) -- the struggles that Pfizer will have over the coming years to bolster its revenue, the possibility of a future dividend decrease -- and combine all this with a tough regulatory environment and uncertain reimbursement issues throughout the world.
If everything goes smoothly in the coming years with Pfizer’s pipeline, and if it can acquire some promising compounds on the cheap, then perhaps its shares will outperform the broader markets. Add all the above potential risks up, though, and there just doesn’t appear to be enough margin of safety embedded into Pfizer’s shares at this for income investors or value hounds to get hyped up about the company. If you want high yield or a defensive pharma pick for the recession, look somewhere safer for now.
Read why Pfizer is finally cheap enough for Brian Orelli, and then vote for a winner of this duel.
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