Although a manufacturer of consumer products, hospital products, and animal health products, Pfizer is known for being the largest producer of pharmaceuticals in the world boasting annual sales of over $46 billion, 58% of which comes from overseas. Some of their well-known patented blockbuster drugs include: Lipitor, Viagra, Zoloft, Celebrex, Zyrtec, Zithromax, and Diflucan. Before the end of the year, pending shareholder approval, Pfizer has agreed to purchase rival Wyeth for $68 billion. Wyeth is also a leading manufacturer of prescription drugs (such as Effexor), over-the-counter drugs (such as Advil, Dimetapp, Centrum, Robitussin), and consumer products (such as ChapStick and infant formula) with $22 billion of annual sales (53% overseas). The combined entity will have a very diversified product base – 17 lines that have annual sales in excess of $1 billion.
The patent on Pfizer’s biggest drug, cholesterol-lowering Lipitor, is set to expire in 2011. No question generic competition will erode profits, but we believe the long-term growth prospects are under appreciated. Their R&D pipeline for new drugs is currently the largest ever and there is plenty of room for international growth. Additionally, with their strong financial position and distribution network, they are a fantastic fit for small companies who need financing to develop new drug ideas and get them through the FDA approval process. The other main concern is the political uncertainty over pending healthcare reform. While strict drug pricing controls would hamper margins, increased drug volume sales from universal coverage and lower prices might alleviate some of the pain.
We estimate free cash flow to be around $2.25/share. Should these aforementioned fears materialize more than we expect, at $15/share, this represents a 15% free cash yield, a substantial margin of safety. In fact, if you analyze cash flows for each drug individually, at this price it’s as if you get the current pipeline as free icing on the cake. We’re happy to collect a hefty dividend while we patiently wait for price and value to converge.
Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.