Pfizer's Pfocus

by Matt Richey (TMF Verve)

ALEXANDRIA, VA (May 27, 1999) -- Yesterday, we looked at Warner-Lambert (NYSE: WLA), a company that derives half of its revenue from non-pharmaceutical products such as candy, razors, and a host of other over-the-counter products you might find in your medicine cabinet. While these consumer health care products offer stable cash flow, they dilute Warner-Lambert's overall profit margins and sales growth. In sharp contrast, Pfizer (NYSE: PFE) focuses almost exclusively on high-margin, high-growth pharmaceuticals. This strategy is riskier than the diversified approach of Warner-Lambert, Johnson & Johnson, and Merck, but offers greater rewards, as well.

More than any other big pharma that we look at this week, Pfizer is pharmaceuticals. Over the past eight years, CEO William Steere has sold all non-drug businesses -- even some good ones. Steere called them "distractions." With last year's divestiture of the Medical Technology Group, Pfizer completed its transformation to a 100% pharmaceuticals business.

During the first quarter of this year, the sales breakdown was 93% pharmaceuticals and 7% animal health. Truly, the animal health division is just an extension of the pharmaceuticals business. Animal health maximizes the company's return on investment in human pharmaceutical research so that even when a compound fails in humans, it might find a use in animals. Very Foolish. Even though animal health sales declined year-over-year, it's still a smart investment.

Overall, Pfizer's first quarter results were tremendous. (Here are the links to Pfizer's earnings press release and 10-Q.) I examined the earnings release back in April, but today let's look at the income statement and balance sheet from a Rule Maker perspective.

Looking first at the income statement, the results were quite impressive. Sales surged by 29% on the strength of Norvasc, the world's #1 anti-hypertensive for cardiovascular-related diseases; Zithromax, the most-prescribed brand-name oral antibiotic for a variety of infectious diseases; and Zoloft, a leading anti-depressant. Sales also benefited from strong alliance revenues associated with the co-marketing of Warner-Lambert's cholesterol-lowering Lipitor and G.D. Searle's arthritis-relieving Celebrex. Meanwhile, slower growth in cost of sales caused gross margins to expand to over 86%. Moving to the bottom-line, net income from continuing operations advanced over 52% with net margins moving up to nearly 21%. Some of these profits were used to repurchase shares, leading to a decline in the diluted sharecount. All in all, a terrific quarter of operations.

But we can't jump to any conclusions without seeking confirmation from the balance sheet. Here, the story isn't as impressive. The cash-to-debt and Flow ratios showed good direction, but still fall well short of our standards. Pfizer now has over $4 billion in cash, but some of that is from increases in short-term debt. According to the 10-Q, the additional short-term debt was partly used to fund the repurchase of shares that led to the sharecount decline. Considering that Pfizer's earnings per share (EPS) for the quarter exactly met the consensus analysts estimate, one might worry that Pfizer had to repurchase those shares to boost EPS to meet the target. I don't know if that's true, but the market certainly reacted negatively to the earnings, and this fact might have contributed to the market's concern. Year-over-year, net cash (cash minus debt) increased by $768 million, but is still negative overall.

On the working capital side of things, the Flowie is an unimpressive 1.89. Seeking answers, I compared Pfizer's accounts receivable, inventory, and accounts payable -- as a percentage of sales -- to three of its competitors:

As a %                Schering-         Warner-
of Sales      Pfizer  Plough     Merck  Lambert
  Receivable  88.4%   49.6%      41.6%  58.9%
Inventory     43.4%   38.2%      33.0%  30.5%
  Payable     16.7%   42.5%      45.0%  60.8%

Check it out -- as a percentage of sales, Pfizer's accounts receivable and accounts payable are off the charts relative to its competitors. If that sentence reads like Greek to you, please take a momentary detour over to Rule Maker Step 7, where we explain the Flowie in simple language. And, as always, help is just a click away in the Rule Maker Beginners folder. According to the footnotes in the 10-Q, the high level of accounts receivables is due to the higher contractual payment terms of alliance revenue receivables, along with the aforementioned strong growth in alliance revenues. The only explanation given for the overly-low accounts payable is "the timing of payments." Okay, that helps. I put a call in to the company, but didn't receive an answer in time for publication. As soon as I find out anything, I'll post my findings to the Rule Maker Companies board.

In sum, Pfizer's first quarter was one of good direction, but there's still plenty of room for improvement on the balance sheet. On the Ranker, the company scores 42 points, which is six less than the last time we scored Pfizer using its fiscal 1998 results. Nothing to quake over, but improvement is definitely needed on the balance sheet going forward.

Looking ahead, Pfizer has promise galore. The company has been spending heavily on research and development (R&D) for years. During the first quarter, Pfizer's R&D spending was well-ahead of the competition, not only as a percentage of sales, but on an absolute basis, as well:

Q1 1999 R&D Spending  ($ millions)
Pfizer                 $ 655
Merck                    442
Schering-Plough          262
Warner-Lambert           234

The R&D pay-off is beginning to show. New medicines in the advanced stage of development create the potential for more than 20 products in Pfizer's drug portfolio by early in the next decade. Treatments for migraine headaches, irregular heart rhythm, schizophrenia, diabetes (inhalable insulin), and breast cancer are just a few of the projects in the works. In addition to these life-saving drugs, Pfizer is also working on life-enhancing drugs, called cosmeceuticals, that aim to improve skin pigmentation, skin wrinkling, and hair loss.

In conclusion, Pfizer's future looks bright as ever. Nevertheless, in the quarters ahead, we'll be watching the balance sheet closely looking for signs of improvement.

For more on Pfizer, I highly recommend Forbes' January Company of the Year article.

See ya on the boards,


05/27/99 Close

Stock Change    Bid
AXP   -2 11/16  116.88
CHV   -1 1/16    93.00
CSCO  -1 1/8    108.00
EK    -1 3/8     68.81
GM    -2         82.88
GPS   +  1/8     60.75
INTC  +1 7/16    53.13
KO    -  3/8     68.13
MSFT  -  1/8     78.38
PFE   +2 7/8    103.88
SGP   -  1/8     44.31
TROW  +  5/16    37.63
XON   -3 1/8     78.81
YHOO  -7 1/2    133.38

                  Day     Month  Year    History
        R-MAKER  -0.69%  -8.10%   3.00%  30.33%
        S&P:     -1.79%  -4.03%   4.56%  29.39%
        NASDAQ:  -0.33%  -4.86%  10.33%  46.36%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     78.38   100.27%
   6/23/98   34 Cisco Syst    58.41    108.00    84.90%
    5/1/98   55 Gap Inc.      34.37     60.75    76.75%
    2/3/98   22 Pfizer        82.30    103.88    26.22%
   2/13/98   44 Intel         42.34     53.13    25.48%
   5/26/98   18 AmExpress    104.07    116.88    12.31%
    2/6/98   56 T. Rowe Pr    33.67     37.63    11.74%
   2/17/99   16 Yahoo Inc.   126.31    133.38     5.59%
   2/27/98   27 Coca-Cola     69.11     68.13    -1.42%
   8/21/98   44 Schering-P    47.99     44.31    -7.67%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     78.81    22.50%
   3/12/98   17 General Mo    72.41     82.88    14.46%
   3/12/98   15 Chevron       83.34     93.00    11.59%
   3/12/98   20 Eastman Ko    63.15     68.81     8.97%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   3762.00  $1883.55
   6/23/98   34 Cisco Syst  1985.95   3672.00  $1686.05
    5/1/98   55 Gap Inc.    1890.33   3341.25  $1450.92
   2/13/98   44 Intel       1862.83   2337.50   $474.67
    2/3/98   22 Pfizer      1810.58   2285.25   $474.67
   5/26/98   18 AmExpress   1873.20   2103.75   $230.55
    2/6/98   56 T. Rowe Pr  1885.70   2107.00   $221.30
   2/17/99   16 Yahoo Inc.  2020.95   2134.00   $113.05
   2/27/98   27 Coca-Cola   1865.89   1839.38   -$26.52
   8/21/98   44 Schering-P   2111.7   1949.75  -$161.95

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1576.25   $289.55
   3/12/98   17 General Mo  1230.89   1408.88   $177.99
   3/12/98   15 Chevron     1250.14   1395.00   $144.86
   3/12/98   20 Eastman Ko  1262.95   1376.25   $113.30

                              CASH     $70.09
                             TOTAL  $31358.34

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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