Drug stocks have taken a hit lately as the market has started to worry about political pressures that may come to bear on pricing and affect profits. But stocks of large pharmaceutical companies can often provide stability in times of market volatility and steady dividend income, too.
Over the last five years Pfizer (PFE 1.51%) has delivered 67% price appreciation plus healthy dividends, compared with a 49% gain for the S&P 500 Index. Will the next five years be as good? Here are five reasons they could be even better.
1. Portfolio losses will slow
As is the case with most established drug companies, Pfizer has had to deal with the expiration of patents and the resulting loss of revenue to generic competition. The company went through several years of loss of exclusivity (LOE) for important drugs such as Viagra and Lipitor. And this summer Pfizer will lose exclusivity for nerve pain treatment drug Lyrica, a source of $4.6 billion, or 8.6%, of the company's revenue last year. Pfizer expects $2.6 billion of headwinds from LOE in 2019 and a decline in Lyrica sales to affect 2020 results as well.
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Fortunately for shareholders, these losses will be slower in the next five years. After the Lyrica LOE, there are no other significant drugs that will become vulnerable to generic competition until the end of 2025.
In the meantime, Pfizer's core portfolio should continue to deliver strong growth. In the latest quarter, the biopharmaceuticals group segment, responsible for 70% of the company's revenue, delivered 11% volume growth and 7% operational growth. Pfizer's top three blockbusters in this group -- Eliquis, Ibrance, and Prevnar 13 -- had 18% revenue growth. No drug accounted for more than 12% of the company's well-diversified portfolio.
2. The near-term pipeline is strong
Pfizer has worked to strengthen and focus its research and development program, beginning with its acquisition of Wyeth ten years ago. Since then the company has cut back from working in 13 therapeutic areas to six, and in 2017 announced its "Up to 15 in 5" initiative, identifying 15 potential blockbusters among the drug candidates in its pipeline that it believes it could launch by 2022.
That initiative was an aggressive goal, and in fact Pfizer isn't going to hit all 15. Two drug developments have been discontinued because they failed in late-stage testing, and a third, tanezumab for pain, is on the ropes, and is probably a loss. But success from even a few of the programs would deliver nice growth five years from now. Pfizer has had approvals in three of the 15 programs and is expecting a decision from the FDA next month for a combination of Bavencio and Inlyta for first line treatment of renal cell carcinoma, and in July for rare disease treatment tafamidis. Phase 3 readouts from three other drugs on this list are expected this year.
There is also some potential upside to the pipeline in the next five years beyond these 15 key programs. Pfizer is building a portfolio of biosimilars and expects up to four approvals this year that together could eventually add up to over $1 billion in annual sales. The company is also working on developing a gene therapy business through partnerships with companies such as Sangamo Therapeutics. Pfizer is a strong partner for small biotechs in this area due to a significant manufacturing capability and an extensive sales force.
3. Small, low-risk acquisitions will continue to build the mid-stage pipeline
Pfizer has enormous cash flow and a strong balance sheet that would enable it to make major acquisitions if it wanted to. But the company has made it clear that it's going to focus on smaller and less risky purchases that add to its areas of focus.
Last week the company announced it's buying privately held biotech Therachon Holding AG for $810 million. Therachon has completed a phase 1 study of a drug for treatment of achondroplasia, a genetic disease that is the most common form of short-limbed dwarfism. The purchase adds to Pfizer's rare disease portfolio and research programs for pediatric growth disorders.
4. Spin-offs will accelerate growth
In the next five years, Pfizer will grow faster by getting smaller. The company has separated out its slower-growth businesses into separate units, and spinning them off would increase Pfizer's growth rate and possibly the stock's valuation.
The one spin-off that's already in progress is Pfizer's consumer healthcare business. Last year the company announced a creative deal with GlaxoSmithKline to combine the two company's consumer units into a single entity that will eventually become a stand-alone company. Pfizer's consumer business is a drag on growth, declining 2% operationally last quarter.
A more intriguing possibility is the spin-off of Pfizer's Upjohn unit. Upjohn is where the company has grouped its drugs that have lost exclusivity or soon will. But the company isn't in a hurry to dump this business. It realizes there is a huge potential market for Viagra, Lipitor, Zoloft, and others in emerging markets where there has been little access to these drugs while prices were high. Pfizer moved a lean Upjohn organization with its management to China to take advantage of the opportunity, and now, according to the company, it's the largest pharmaceutical company in that country. The business is predictable with its high cash flow and low risk.
When asked recently if Upjohn might be spun off, CEO Albert Bourla said that it is a possibility, but the priority now is to strengthen that business. I think there's a strong likelihood that the separation will happen within five years. When it does, Pfizer should get two benefits: a big infusion of cash and a faster growth rate.
Pfizer is valued at about four times revenue. If we conservatively estimate that Upjohn would go for half that at twice annual revenue, it would be worth about $25 billion. Pfizer's revenue grew 1.6% in the latest quarter. Without the consumer and Upjohn businesses, revenue growth would have been 3.4%. Spinning off these two groups in the next five years could easily add two percentage points of growth to the top line and more than that to earnings growth.
5. Dividends will continue to grow
Pfizer pays a generous 3.5% dividend and has plenty of cash flow to allow it to continue raising the payout each year. Last year the company had $15.8 billion in operating cash flow and used $8.0 billion for paying the dividend and $12.2 billion in share repurchases. Pfizer views the share repurchases as a way to keep earnings per share rising in a time of stagnant top line growth without having to cut the research and development budget.
Share repurchases will be cut back to $9 billion in 2019, and once revenue growth picks up again, the company should have even more flexibility with capital allocation. Dividend growth is a priority for Pfizer, so we could see dividends growing faster than the 6% increase in 2018. But if we conservatively estimate that the company will continue raising the quarterly payout by $0.02 every year, which has been the pattern since 2010, the dividend would increase 28% in the next five years, with plenty of upside potential when top line growth resumes.
Risks
Of course things could go wrong for Pfizer. The market is obsessing over "Medicare for All" and other proposals being floated in advance of next year's election that could result in new pressures on drug prices. Drug companies have faced this for years in the form of pressure from insurance payers and pharmacy benefit managers and have largely factored declining prices into their plans. But if a major change to the country's healthcare system happens, Pfizer would be affected along with the rest of the sector.
Drug trials can fail and new competitors can arise, but Pfizer is in a better position than most, with a lot of promising drug candidates in its pipeline and a diversified portfolio that isn't overly dependent on sales of any particular medicine.
Pfizer's slow growth may seem unexciting, but a predictable business paying a high dividend may be just what the doctor ordered. The drug giant outperformed the market the last five years, and the evidence points to even better results for patient shareholders in the next five.
