At a recent price of $27.17, shares of pharmaceutical giant Pfizer
The near future
2007 may not turn out to be Pfizer's year either, but it's still my pick as the best drug stock for 2007 for a couple of reasons, starting with an above-average dividend yield. Pfizer's current dividend yield is 4.3%, meaning that investors are getting paid to wait for Pfizer's fortunes to turn around.
So why would anyone care to wait around for a stock that has chronically disappointed investors? For starters, even in its current form, Pfizer is a cash-generating machine. It is currently struggling to replace revenue, since drugs brought to market in the 1980's, such as Zithromax and Zoloft, are losing patent protection. Additionally, the company recently had a major setback when a drug called torcetrapid failed late-stage clinical trials. Torcetrapid had been earmarked to lessen the blow of cholesterol drug Lipitor's approaching patent expiration around 2010, as Lipitor accounted for about $12 billion of Pfizer's $51 billion in 2005 sales.
But even with the top-line shrinkage, Pfizer generated about $12.6 billion in 2005 free cash flow. Back in June, then-CEO Henry McKinnell projected $16 billion in free cash flow (or approximately $2.20 per share) for 2006, although this was before the sale of the consumer healthcare business to Johnson & Johnson
That's a lot of capital. And that capital has been used for many purposes: increasing the dividend, which Pfizer has done for decades; buying back shares, which it did in 2006 and plans to continue in 2007, to the collective tune of $16 billion; and pursuing acquisitions, which is also part of the capital allocation policy and will bring new products into the corporate fold.
Patent expiration woes are expected to settle down once 2007 ends, after which the next hurdle will be Lipitor's expiration. But in the meantime, management will be cutting costs and developing new drugs with the goal of generating around $19 billion in annual free cash flow within a couple of years. Based off the current share count, that works out to about $2.60 per share, for a compelling price to free cash flow multiple of under 11.
As I detailed recently in a duel over archrival Merck's
The potential of Pfizer's pipeline stands up against most peers, with close to 20 products in or close to registration as of the end of last year. It is also pursuing a diversified approach by finding cures and treatments in as many therapeutic areas as possible, be it cardiovascular, arthritis, oncological, or other infectious diseases.
It won't be easy, and currently Pfizer has little to show for the $7 billion to $8 billion it spends annually on research & development. But return on invested capital is still hovering around 20% and is about as high as you'll find at any company. Investors can take solace in the fact that Pfizer continues to be very profitable and the low valuation and high dividend offer downside protection, should future growth come in at the low end of expectations.
Mountains? Or molehills?
As a contrarian, I believe the market is focusing too much on past frustrations. My money is riding on at least a couple of positive pipeline developments within the next couple of years, which will get growth moving in a positive direction once again.
Discover our other Foolish candidates for the best drug stock for 2007.
Fool contributor Ryan Fuhrmann is long shares of Pfizer, but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.