RULE MAKER PORTFOLIO
A Review of Pfizer's Results

By Phil Weiss (TMF Grape)

TOWACO, NJ (January 25, 2000) -- Tonight I'm going to review Pfizer's (NYSE: PFE) fourth quarter and full year earnings report. Since Pfizer's report only includes its income statement, I'll only be able to give the numbers a partial dose of the usual Rule Maker scrutiny. I'll also refer to the supplementary Q&A report that Pfizer issued along with its earnings release.

One thing that I'm not going to talk about tonight is the latest episode of who's going to merge with whom. I invest in companies because of their independent prospects for the future. I don't worry all that much about mergers until they're agreed upon. If Pfizer does end up merging with Warner-Lambert (NYSE: WLA), I'll do more serious evaluation of that combination at that time. If the merger doesn't go through, then I'll evaluate the impact on Pfizer's future at that time as well. There's no real point for a Rule Maker investor with a long-term focus to spend a lot of time on short-term noise.

Instead, what I'd like to do is run Pfizer's income statement through our Rule Maker criteria.

Sales Growth of at least 10% -- Something that seems to be commonplace for Pfizer lately is that its overall revenue growth looks quite strong. Total revenues for the quarter were up 17% over last year's fourth quarter and 20% for the year. But, as I mentioned last quarter, Pfizer breaks its revenues down into two components -- Net sales and Alliance revenues. Net sales represents the revenue Pfizer generates from the sale of products that are developed, manufactured, marketed and sold by Pfizer. These sales were up a somewhat disappointing 9% over the year ago quarter and 11% for 1999 overall. On the other hand, alliance revenues were up by 107% over the same quarter a year ago and 139% for the year. Alliance revenues represent Pfizer's proceeds from its co-marketing agreements with Warner-Lambert for Lipitor; Monsanto (NYSE: MTC) for Celebrex; and Eisai for Aricept.

Currently five products that Pfizer developed have sales of over $1 billion, which means that they are classified as blockbusters. Norvasc (hypertension), which grew by 14% for the quarter is Pfizer's sales leader with over $3 billion of revenue in 1999. Sales of Zoloft (depression) grew by a disappointing 6% for the quarter and by 11% to $2 billion for the year. If you're a parent, and your child has had ear infections, then you're probably familiar with the antibiotic Zithromax, which grew by 21% for the quarter and 28% for the year to $1.3 billion. Viagra (erectile dysfunction) and Diflucan (antifungal) grew by 31% and 9%, respectively, during the fourth quarter and both passed the $1 billion mark in annual sales for the first time.

For me, the relatively slow growth of revenue from Pfizer's in-house developed products is becoming part of a disturbing trend, so I decided to take a closer look at the historical numbers. Pfizer first had alliance revenues in the second quarter of 1997. Since that time, revenues from Pfizer-developed products have grown at an annualized rate of 13% while alliance revenues have grown by 146% per year.

I realize that it takes time to successfully develop a new pharmaceutical product, but I expect better results from Pfizer's research and development (R&D) efforts, especially in light of the troubles some of the once-promising products in Pfizer's pipeline have had over the last year. For example, in the third quarter, a potential blockbuster drug, Trovan, was essentially withdrawn from the market. There have also been a number of delays related to the schizophrenia drug Zeldox (the Q&A says that a New Drug Application (NDA) will be filed for this drug in the first quarter).

We can expect to see Pfizer start selling the anti-arrhythmic agent Tikosyn and the migraine medication Relpax in the near future, but I've read mixed opinions as to whether or not these drugs will generate blockbuster level revenues for Pfizer. If you read Q&A numbers 23 and 24, you'll see that the company has a number of other drug candidates in its pipeline, but it's never certain that any drug in clinical trials will be sold to consumers.

What troubles me the most is that over the last 11 years Pfizer's investment in R&D has grown from $401 million to $2,776 million -- an annualized rate of over 19%. As a result, R&D as a percentage of sales has increased from 10% to 17%. In fact, Pfizer's R&D as a percentage of sales is more than 25% higher than any other pharmaceutical company that I've analyzed, yet it hasn't at all led to exceptional revenue growth. With that kind of industry-leading investment in research, I'd like to see a higher rate of revenue growth for Pfizer-developed products.

Pfizer has also made a significant investment in its sales force. Even as pharmaceutical companies increasingly market their drugs directly to consumers, the primary means of marketing those drugs is to send sales reps directly to the doctors who write the scripts. Pfizer's investment in its sales force has paid off, as it's one of the driving factors in the growth of its alliance revenues. As a matter of fact, in a recent survey of more than 10,000 physicians, Pfizer's sales force was ranked first overall for the fifth consecutive year. It was also ranked either first or second in half of the 28 medical specialties surveyed.

Gross Margins of at least 50% -- Pfizer's gross margins for the quarter were 85%, which is an impressive increase from last year's figure of 82%. However, for the full year, gross margin declined from 85% to 84%. This is primarily attributable to the $310 million charge that Pfizer took during the third quarter related to Trovan inventory write-offs. Last quarter, Pfizer separated this charge in presenting its results from continuing operations.

I do not agree with that point of view for a couple of reasons. One is that Trovan may still be sold in a limited quantity in the future. Another is based upon the fact that Pfizer is a pharmaceutical company and this charge was incurred in the conduct of Pfizer's normal business. The company had a problem with one of its drugs for which it has recorded sales income in the past and present. Finally, this charge cost Pfizer real money. It's much different than the non-cash acquisition-related charges and/or non-cash amortization that are often excluded when calculating results. My opinion is that unless Pfizer treats the revenues from this product the same as it treats the costs of production, the write down of this inventory should not be excluded from operating income.

Net Margins greater than 7% -- Pfizer easily passes this hurdle. During the fourth quarter, Pfizer's net margin was 21%, up from 18% a year ago. This is a positive development as it gives Pfizer the flexibility to invest in the growth of its business via both future research and further build-out of its sales force. Pfizer has also been using some of this handsome profit margin to return cash to its shareholders in the form of stock buybacks. The number of shares outstanding declined by 2% over the year ago figure. But, as I've discussed in the past (Pfizer's Approach to its Business -- Parts One and Two), until we see the fourth quarter balance sheet and cash flow statement, we won't know the full picture in terms of how Pfizer is managing its business.

I'll be quite interested to see what Pfizer's balance sheet and cash flow statements look like when they're released in March. I'd like to see some improvements in our company's flow ratio as well as its ratio of cash to debt. In this Fool's view, Pfizer's quarterly results as reflected in its income statement continue to raise some questions. Hopefully, there will be some improvements in the balance sheet that will mitigate some of what's found in the income statement.

Phil (TMFGrape on the boards)


 




Rule Maker Portfolio

1/25/00 Closing Numbers
Ticker Company Dly Pr Chg Price
AXPAMER EXPRESS3/8$158.38
CSCOCISCO SYSTEMS1/16$112.13
GPSGAP INC3/4$44.31
INTCINTEL CORP3/4$101.56
KOCOCA-COLA CO1$65.88
MSFTMICROSOFT CORP9/16$102.81
PFEPFIZER, INC1/2$34.88
SGPSCHERING-PLOUGH7/8$40.81
TROWT.ROWE PRICE ASSOC7/8$42.38
YHOOYAHOO INC21 1/4$345.56

  Day Week Month Year
To Date
Since
2/2/98
Annualized
Rule Maker 2.95% -.16% -.95% -.95% 72.63% 31.76%
S&P 500 .58% -2.17% -4.03% -4.03% 43.84% 20.16%
S&P 500(DA) .58% -2.17% -4.03% -4.03% 45.61% 20.90%
S&P 500(DCA) n/a n/a n/a n/a 27.65% 13.13%
NASDAQ 1.74% -1.61% 2.41% 2.41% 157.35% 61.21%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
6/23/9875CSCO32.865$112.13241.17%
2/17/9916YHOO126.309$345.56173.58%
2/3/9859MSFT49.352$102.81108.32%
5/1/9882GPS22.708$44.3195.14%
2/13/9865INTC53.762$101.5688.91%
5/26/9818AXP104.067$158.3852.19%
2/3/9866PFE27.433$34.8827.13%
2/3/9856TROW33.673$42.3825.84%
2/27/9827KO69.107$65.88-4.68%
8/21/9844SGP47.993$40.81-14.96%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
6/23/9875CSCO$2,464.86$8,409.38$5,944.52
2/17/9916YHOO$2,020.95$5,529.00$3,508.05
2/3/9859MSFT$2,911.79$6,065.94$3,154.15
2/13/9865INTC$3,494.54$6,601.56$3,107.02
5/1/9882GPS$1,862.06$3,633.63$1,771.57
5/26/9818AXP$1,873.20$2,850.75$977.55
2/3/9866PFE$1,810.58$2,301.75$491.18
2/3/9856TROW$1,885.70$2,373.00$487.30
2/27/9827KO$1,865.89$1,778.63($87.26)
8/21/9844SGP$2,111.70$1,795.75($315.95)
  Cash: $6,133.67  
  Total: $47,473.04  


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.