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Pfizer, Inc.
PFE DCF Analysis

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By rhill0123
November 24, 2004

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I've been long PFE for several years now and recently increased my stake. As part of my general analysis, I generally do a DCF calculation to see where things stand.

In my model, I used 2.13 EPS as a proxy for FCF/share, with a growth rate of 10% annually for 5 years, followed by a growth of 7% annually for the following 5 years, and finally, a growth a 5% annually for the next 10 years. I valued the ongoing business by assuming that the business will be worth 5 times earnings in the 20th year.

I applied a discount rate of 11%, as I think PFE represents not substantially greater risk than the market in general.

Under these assumptions, the net present value of future earnings is $37 per share. Of the $37 per share, about $10 is paid out in dividends, $22 is in retained earnings, and $5 represents the terminal (ongoing value). (I am assuming that dividends increase at a rate equal to earnings increases).

Now for some QA checks on the assumptions:
(1) Are the total earnings reasonable? In year 20, this shows total earnings to be $59B. This doesn't seem impossible. Exxon Mobile earned ~23B in the last 12 months. PFE is projected to earn around $15B this year. I think it is possible for a well-positioned company to generate this level of earnings in 20 years.
(2) Do the EPS growth rates seem reasonable? I think the biggest risk is over the first 5 years. With Lipitor going off-patent, PFE has a big hole of revenue to make up. Much will depend on their R&D output. This has been unfavorable in the past, IMHO (note y/y sales growth is anemic at around 5%!). Still, there are substantial cost savings through merger consolidation yet to be eked out. I note that current analyst projection is for 11% EPS growth for 5 years. Still, I think this is the weak link in the assumptions table. More later on.
(3) Is the terminal value too big? I feel least comfortable in my analysis of terminal value and if it comes up to big a major component of the value, I get worried. Here the terminal value is about 13% of the total NPV. That doesn't seem too bad.
(4) Is the discount rate sufficient? I don't know. I generally use values around 11% for established large enterprises with substantial competitive advantages. I commonly use %15 for smaller firms and higher for more risky propositions.

The weak link seems to be in the earning estimate (as it generally is). If I assume that growth is 7% for the first five years rather than $10, it takes the value per share down to around $33. If I assume that growth is zero for the first five years, it takes the value to $24. If I assume that analyses are dead on, at 11%, then we're back up in the $39 range.

In short, with this analysis, it seems that purchasing PFE in the mid to high 20s, you get the stock with a substantial margin of safety if you believe double-digit growth forecasts over 5 years.

If you believe more moderate growth, you are still buying at a discount, but it is less significant.

If you believe a no-growth scenario in the near-term, then you might be overpaying or paying around fair value.

Weighing the probabilities, it seems to be likely that PFE is worth at least $32-$34 per share. Buying at these levels provides a margin of safety to handle some nuclear winter scenarios like Merck investors just felt with VIOXX. These really could happen (imagine what might be lurking in Pfizer's internal email system!) and should be considered by the investor.

Comments? Opinions welcome...

Rob


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