Cash Is King for Pfizer

We often hear the old saying that "cash is king" when the financial system is crumbling and investors from east to west are panicking. In those times, the Fool with cash can pick up a bunch of bargains and, as Warren Buffett did in 2008, be a lot more demanding when negotiating with the man who needs cash.

However, cash is important at other times, too. Consider Pfizer (NYSE: PFE  ) , which generates large amounts of cash and is arguably the king of its sector.

Indeed, Pfizer is the world's largest research-based pharmaceutical company and sells a vast range of drugs, including some that you've seen at the local pharmacy and many others that are specialist, prescription-only drugs.

Its cash flow is quite simply staggering, with operating cash flow in 2012 of more than $17 billion. Furthermore, with capital expenditures being relatively low at $1.3 billion, free cash flow is a whopping $15.7 billion.

Of course, Pfizer is 150 years old and so is a mature business operating in a very mature market, so high levels of free cash flow are perhaps to be expected.

However, what's impressive about Pfizer is that its free cash flow yield (free cash flow as a proportion of its market capitalization) is just over 8%, which is extremely high. This indicates that Pfizer offers good value at current levels, and, in addition, this level of free cash flow is unlikely to be a one-off event, since the company should be relatively stable in future years as it brings new drugs onto the pipeline while others go off-patent.

The big question, though, is whether Pfizer is doing the right things with its cash.

Last year it paid out $6.5 billion in dividends, which is 41% of free cash flow. For such a mature company with such minimal capital expenditure requirements, this seems rather low, and it could reasonably be argued that a higher payout ratio is deserved.

Indeed, rivals such as AstraZeneca and GlaxoSmithKline pay out a considerably higher proportion of free cash flow as dividends.

In AstraZeneca's case, it paid out 58% of free cash flow as dividends last year, which trumps Pfizer even though AstraZeneca is going through a more difficult time with regard to its "patent cliff." Sure, Pfizer has had issues of its own on this front, dealing with many of its key drugs coming off-patent, but it has dealt relatively well with the situation overall.

AstraZeneca, on the other hand, has struggled until this year to get its act together and build an encouraging pipeline. Yet it is still more generous with its cash than Pfizer.

Meanwhile, GlaxoSmithKline paid out 115% of its free cash flow as dividends last year, although it hasn't experienced the issues with its drug pipeline that AstraZeneca or Pfizer have. Such a level is unsustainable in the long run, but it shows how generous GlaxoSmithKline is compared with Pfizer.

Despite this relatively low payout ratio, Pfizer still offers a yield of 3.2% and has a great pipeline of drugs, where significant progress has been made in the past couple of years as the company refocuses its efforts on drug development rather than on consumer brands.

Although a higher yield would be great for shareholders, Pfizer still offers great value (as shown by the free cash flow yield), relatively stable cash flow, the potential for positive drug pipeline developments, and an above-average dividend yield.

Cash is Kkng. On that basis, Pfizer still seems to be the (somewhat ungenerous) king.

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