Last week Pfizer (NYSE:PFE) reported its Q3 earnings, where it witnessed a significant decline in revenues. While a decline in sales was already on the cards, the unexpectedly weak performance by Prevnar disappointed many, sending the stock below $25. Also, the company recorded a decline in overall gross margins, as expected. (Read Pfizer Earnings Decline As Prevnar And Emerging Markets Disappoint)
Drugs like Prevenar hold the key for future growth as the company has been grappling with the issue of patent cliffs and has seen its sales slumping in the last couple of quarters. Lipitor, which generated close to $10 billion in 2011, has lost more than half of its sales in a relatively short time frame. The looming patent expiration for Enbrel, Detrol, among others, in 2012 will also hurt revenues.
Looking at the trends from the latest earnings, we find it prudent to examine the stock’s dependence on Prevenar franchise and its gross margins. One observation is that if the company sees a stagnant growth in its revenues from Prevenar franchise coupled with a steep decline in the gross margins, the stock value could decline by about 15% from our $26 price estimate,which we are in the process of updating to reflect the earnings.
1. Revenue from Prevnar & Prevenar (7 & 13): This is the total worldwide revenues generated by the Prevnar franchise of vaccines.
2. Pfizer Gross Margins: This represents the company’s gross profits expressed as a percentage of the company’s revenue. Gross profit is defined as revenues minus the cost of goods sold.
15% Downside Scenario | $23 Trefis Price Estimate
1. Lower Revenue From Prevnar & Prevenar (7 & 13) (-5%):
Revenue from Prevnar & Prevenar (7 & 13) was close to $300 million in 2009, which grew to more than $3.5 billion in 2011 due to the addition of the Prevenar vaccines after the acquisition of Wyeth and expanded use of the vaccine. The vaccine remains a distant market leader even as it competes with Merck‘s (NYSE:MRK) Pneumovax.
The vaccine has shown consistent double digit growth rates in the last couple of quarters and we expect the vaccine sales to more than double by the end of our forecast period. The U.S. Centers for Disease Control and Prevention (CDC) recently recommended Prevenar 13 for adults aged 19 years or older with impaired immune system. Further, the vaccine received World Health Organization (WHO) qualification for use in adults aged 50 years and above, which means WHO member countries can now use the vaccine for older patients. According to the World Health Organization estimates, nearly 1.6 million people die each year from pneumococcal infections.
The expected growth, however, hinges on broader recommendations the vaccine is awaiting, including the extension to young adults of ages 18 and 19. But we believe the positive results from the recent clinical trial will strengthen Pfizer’s bid to get approval for the vaccine. The vaccine is also awaiting the U.S. CDC recommendations for all adults aged 50 years and above. Health plans in the U.S. usually wait for the CDC recommendations to cover a vaccine’s use. While the FDA approved the vaccine for the above age group last December, the CDC is waiting for the efficacy results of an ongoing clinical study (Pfizer expects to complete the trials by 2013) before deciding on broader recommendations. All these approvals will open the bigger market for the vaccine and will drive the growth.
However, If Pfizer doesn’t get these much-awaited recommendations, the vaccine’s sales could witness stagnant growth or could even see a decline in the growth as witnessed in the recent quarter. (Read Pfizer Earnings Decline As Prevnar And Emerging Markets Disappoint)
The division is one of the largest revenue contributor and constitutes more than 10% of our price estimate. Hence, even a small under-performance with respect to our expectations will have a big impact on Pfizer’s valuation. If the revenues from the vaccine remain stagnant at $5 billion by the end of our forecast period, this could translate in 5% downside to our current price estimate of $26.
2. Lower Gross Margins (-10%):
Pfizer’s gross profit margin increased to 80% in 2011 from 78.5% in 2007 mainly due to highly priced patented drugs and favorable foreign exchange impacts. We, however, expect the company’s gross margins to decline through the end of Trefis forecast period due to a number of factors. The company is seeing many of its popular drugs, including Lipitor, Enbrel and Detrol lose patent protection recently. Further, the revenue share of international markets, particularly emerging markets, has been rising. As the company focuses on price sensitive emerging markets and as austerity measures by governments across the globe and increasing competition from cheap generics forces the company to cut prices, margins could decline from current levels. We, however, expect synergies from Wyeth’s acquisition and various collaborations to mitigate the decline to some extent.
But, as witnessed in the recent past, a strong U.S. dollar can put more strain on margins as many countries have seen a sharp depreciation in their currencies. Further, a continuance in European austerity measures could hurt margins more than we currently anticipate.
If these factors abet the drop in margins and the margins drop below 70% by the end of Trefis forecast period (as against our expectations of close to 75%), this will represent a close to 10% downside to our price estimate.
Combining both scenarios, a 5% downside from lower revenue Prevnar & Prevenar (7 & 13) and a 10% downside from lower gross margins, we arrive at more than 15% downside or a price estimate of $23 for Pfizer.