Pfizer (NYSE:PFE) is among the biggest pharmaceutical research & development (R&D) spenders globally with close to $7.87 billion spent last year. The company has however been trying to lower these expenses to sustain profits amid loss of patent exclusivity of several major drugs.
Pfizer’s R&D expenses dropped from $9.48 billion in 2010 to $7.87 billion in 2012.  As a percentage of revenues, the figure came down from 14.55% to 13.34% during the same period as the company actively trimmed its R&D budget. A significant portion of this R&D downsizing can be attributed to Pfizer’s withdrawal from cardiovascular drug research.
Will there be more R&D cuts going forward? The recent developments suggest that there might be in the near term as Pfizer restructures its business to divert resources to certain key growth areas such as oncology (cancer treatment), and reduces spending in other therapeutic areas. During its second quarter earnings release, Pfizer announced its decision to reorganize its business into innovative and value segments which would lead to better focus and efficient resource allocation. Over the longer term, we believe the company will need to step up its R&D efforts to counter competition from generics and recover the sales lost due to patent expiry of key cardiovascular drugs.
How Does Pfizer’s R&D Pipeline Look?
At the end of 2012, Pfizer had 276 projects in research and development that ranged from discovery through registration. Out of these, 78 programs were in phase 1 through registration with the remainder in pre-clinical development.  The figure looks small compared to 2011 when the company had 92 programs in phase 1 through registration. The Phase 3 portfolio also reduced in 2012 and had only 17 programs.  Pharmaceutical R&D is a very complex process and it appears that Pfizer is cutting corners in areas where it isn’t getting encouraging results. By May 2013, the number of programs in phase 1 through registration further reduced to 74 and the company’s R&D expenses fell to 12.76% in the first half of 2013. 
Withdrawal From Cardiovascular Drug Research
In 2008, Pfizer announced that it will stop developing cardiovascular drugs as part of its broader research reshuffling and instead focus on more profitable markets such as oncology. The company knew that the market would get increasingly flooded by generics and that it would be difficult to develop a drug that could successfully replace Lipitor after its patent expired. In fact, Pfizer was banking on a cholesterol-lowering drug called torcetrapib, but it failed a major study in late 2006.
Lipitor was the world’s largest selling drug at one point. It lost its patent protection in November 2011, and Pfizer’s cardiovascular division has been suffering ever since. From about $10 billion in 2011, Lipitor sales declined to about $4 billion in 2012 as generics penetrated the market. Its worldwide sales further plunged by 55% in the second quarter of 2013.  The drug has lost patent exclusivity in Europe and is facing multi-source generic competition in the U.S. Another drug Caduet, a pill combining Pfizer’s Lipitor and Norvasc for prevention of cardiovascular events, also lost exclusivity in the U.S. in November 2011 and in other markets in 2012. Benefix also lost patent protection in 2011. Both these drugs generated more than $1 billion in sales in 2011. The company doesn’t have any plans to invest significantly in cardiovascular R&D to revive this segment.
Where Will Pfizer’s Trimmed R&D Operations Focus On?
We believe that Pfizer is likely to focus more on oncology and immunology, which appear to be the key growth areas for the pharmaceutical industry. While the company’s cardiovascular drug business remained weak during the recent quarter, oncology (cancer treatment) drugs showed rapid growth. Pfizer’s global oncology sales increased 24% in Q2 2013 with year-to-date sales up 26%.  Oncology can help Pfizer command better pricing as primary care areas such as cardiovascular get flooded with generics. The company’s focus in this area is evident from the fact that 3 out of 6 drugs in its late stage program are intended for cancer treatment.  These include Palbociclib for breast cancer, Inotuzumab Ozogamicin for aggressive non-hodgkin’s lymphoma and acute lymphoblastic leukemia, and Dacomitinib for non-small cell lung cancer.
The opportunity in cancer therapeutics comes from the fact that the global incidence of cancer is likely to increase from about 12.7 million in 2008 to 21.3 million in 2030.  In addition, the number of deaths are likely to show a similar growth trajectory as depicted in the chart below. Cancer is a not a single disease, it has in fact more than 200 types and thousands of subtypes affecting more than 60 organs. That gives an opportunity for Pfizer to develop novel therapies and capture niche markets. But will that mean more R&D expenses? We believe that in the near term the company can keep its R&D expenses in check by diverting resources from low growth therapeutic areas to oncology. That may not be true in the longer term as rivals are also directing their efforts towards cancer therapies. The company is likely to spend more in the longer term in order to have a competitive advantage.
Source: J&J’s Investor Presentation
Our price estimate for Pfizer stands at 31.26, implying a premium of about 10% to the market price.