Pfizer, Inc. (PFE) is undergoing a massive transformation over the past two years driven by the new CEO. Once complete it will be a whole new ballgame for Pfizer. The company will be focused on research & development for prescription medicines. It will only be involved with consumer healthcare products and off-patent and generic products through joint ventures. Pfizer may be an interesting pick for investors seeking yield, dividend growth, and potential for capital gains. The current yield is over 4.7%, which is more than double that of the S&P 500. The dividend safety metrics are decent at the moment but will likely take a hit after the Upjohn spin-off. The stock is a Dividend Contender and has paid a continuous dividend for 325 consecutive quarters or over 81 years. After Upjohn is divested, Pfizer should be positioned for higher growth and margins. I view the stock as a long-term buy.
Overview of Pfizer
Pfizer Inc. is a global pharmaceutical company that focuses on prescription drugs and vaccines. The company traces its history to 1849. Pfizer’s new CEO completed a series of transactions in 2019 significantly altering the company structure and strategy as discussed below. The company has strengths in cardiovascular, oncology, inflammation & immunology, vaccines, rare diseases, sterile injectables, and anti-infective medicines. Pfizer’s top products include Eliquis (cardiovascular – blood thinner), Ibrance (oncology), Prevnar 13 (pneumococcal vaccine), Enebrel (inflammation and immunology – international), Chantix (smoking cessation), Sutent (oncology), Xtandi (oncology), Vyndaqel (rare disease), Inlyta (oncology), and Xeljanz (rheumatoid arthritis). The company had revenue of $51.8B in 2019 making it one of the world’s largest pharma companies based on revenue.
Pfizer is in the midst of completing three deals that taken together will transform the company. These deals are all being driven by the new CEO, Albert Bourla. He has over a 25-year history at Pfizer. This is part of a longer-term trend. Pfizer has previously divested the nutritional and animal healthcare businesses.
First, in 2019, Pfizer formed the GSK Consumer Healthcare Joint Venture with GlaxoSmithKline plc, which will include Pfizer’s over-the-counter business. Pfizer owns 32% of the joint venture. In this deal Pfizer divested major brands such as Tylenol, Advil, Centrum, Robitussin, Chapstick, and others. GlaxoSmithKline divested brands like Excedrin, Theraflu, Sensodyne, Flonase, and others. Together the JV has scale and sales of over $12 billion. The JV will effectively be the global market leader in over the counter drugs with the No. 1 or No. 2 position in different categories and geographies.
Source: GSK Consumer Healthcare Joint Venture Investor Briefing
Pfizer also completed an $11B deal in 2019 to acquire Array BioPharma. This deal was done to strengthen Pfizer’s product pipeline in oncology. Array BioPharma focuses on targeted small molecule medicines to treat cancers and other diseases. The company received approvals in 2018 for the combination of Braftovi and Mektovi for treatment of certain types of melanoma. Pfizer has continued to expand R&D for these medicines. Pfizer recently received FDA approval for Braftovi in combination with Erbitux. Sales are increasing for the two acquired medicines to $37 million each in Q1 2020. Array BioPharma had only $35 million in net sales when acquired. With that said, sales of the two medicines will need to increase much more in the future to make this deal worthwhile over time.
The third deal is the spinoff of the Upjohn segment, which focuses on off-patent and generic therapies. The deal was announced at the end of 2019 and is expected to be completed in the latter half of 2020. Upjohn will combine with Mylan Inc (MYL) to form a joint venture called Viatris. Viatris will sell off-patent branded and generic medicines including Lyrica, Lipitor, Norvasc, Viagra and Celebrex. Pfizer is also spinning off Meridian, the manufacturer of EpiPen as well as Mylan-Japan an existing JV since 2012 to Viatris. Upjohn is facing challenges and sales have been declining due to stiff competition to Lyrica and other off-patent medicines. In fact, all off-patent medicines exhibited steep declines in the latest quarter except EpiPen and Zoloft in the U.S. In China, generic prices have been slashed and most contracts were awarded to local companies. Pfizer will own about 57% of Viatris once the deal is completed.
What About Pfizer’s Dividend?
Pfizer is yielding over 4.7% as of this writing. That is better than many REITs and MLPs right now since many had to temporarily suspend or cut the dividend. With that said, Pfizer’s dividend may be impacted by the upcoming divestment of Upjohn to form Viatris. After the spinoff of Upjohn, the new Pfizer will have operating cash flow of $10B to $11B. Pfizer had capital expenditures of $2,176M in 2019. Let’s assume capital expenditures drop to $2B and operating cash flow is at the higher end of the above range. This gives free cash flow of $9B. The annual dividend will cost about $8B meaning that the dividend-to-FCF ratio will be about 89%. This is much too high from the perspective of dividend safety. In general, I like to see this ratio at 70% or below. The high ratio suggests a future dividend cut after Upjohn is divested.
Final Thoughts on Pfizer
Why invest in Pfizer if one is seeking income and dividend growth and the dividend may be cut? Even if we project a 25% dividend cut Pfizer’s dividend yield will still be above the S&P 500’s average yield. Further, Pfizer will receive about $12B in cash from Upjohn as part of the spinoff. This money will be used to pay down debt improving Pfizer’s balance sheet and reducing leverage. Next, Pfizer’s possible dividend cut will be made up at least in part by Viatris. Viatris intends to initiate a dividend based on 25% of free cash flow. Granted, Viatris will not be a high growth company and its product portfolio will have challenges in driving top line growth.
On the other hand, the new Pfizer will be positioned for higher growth and margins and potentially dividend growth over the long-term. With an improved balance sheet and lower leverage Pfizer could potentially pursue another acquisition to shore up its product pipeline. Further, I view it as unlikely that Pfizer will hold onto shares of either JV over the longer-term. Pfizer’s CEO has indicated that he sees the consumer healthcare JV heading to an IPO in three or four years providing a clear exit strategy. In my opinion, Viatris will also head for an IPO at some point in the future. So, the combination of a higher growth at the new Pfizer albeit with a lower dividend and the possibility of some capital gains and IPOs in new companies may be interesting to some small investors.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.