These Three Factors Can Trigger Movement In Pfizer’s Stock Price

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Several of Pfizer‘s (NYSE:PFE) drugs are at a mature stage and thus facing competitive pressure from generics. The company is looking at new avenues for growth, and is certainly not opposed to possibility of large acquisitions, besides small tie ups to boost R&D pipeline. The recent patent cliff has significantly impacted the company’s sales and we currently value its stock at $35, implying a slight premium to the market. However, there are certain triggers and plausible developments that can move the stock significantly in the next couple of years, assuming the market prices in these triggers correctly. Specifically, we believe the possibility of a large acquisition, better-than-expected results from drugs currently in phase 3 trials, and a failure to rationalize R&D spending are some of the key plausible events that can trigger stock price changes for better or worse.

See our complete analysis for Pfizer

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Major Acquisition Results In Lower Tax Base And Boosts Drug Sales (+15%)

Our base estimates for Pfizer do not include any major acquisition by Pfizer as we model such business transactions once they are announced and subsequently closed. However, the possibility still remains on the cards as Pfizer has history of making big acquisitions. Even though its CEOs have initially taken a position against deploying a strategy of acquisition to drive growth, they have inevitably made some of the industry’s biggest business purchases such as Warner-Lambert for $112 billion in 2000, Pharmacia for $60 billion in stock in 2003, and Wyeth $68 billion in 2009.

Pfizer’s management made another such attempt last year when it failed to acquire AstraZeneca. The deal was primarily motivated by the company’s interest in AstraZeneca’s oncology pipeline and tax inversion. Pfizer recently announced the acquisition of Hospira, but that’s much smaller than what it would have ideally wanted. The company has stated that it is not opposed to any future deals that may result in tax savings, even though new tax laws are making such transactions less attractive. There are still some good candidates, and if the company can save annually more than $1 billion taxes through a tax inversion deal, as it was planning in case of AstraZeneca, it can add roughly 7% to is value. However, considering Pfizer’s emphasis on financial discipline, we expect such big acquisition to create additional cost synergies as well as potential block-busters in the area of immuno-oncology, vaccines or Hepatitis C. We believe these aspects can add another 7-10% to the company’s value, by boosting profits by $1-1.5 billion, resulting in overall valuation boost of approximately 15%.

Mid-To-Late Pipeline Firing In The Next Few Years (+10%)

Pfizer is confident about its R&D pipeline with renewed focus on growth products. Currently, the company has around 10 drugs in phase 3 trials and 12 in phase 2 (important ones). Phase 3 status is interesting as Pfizer is currently testing some biosimilars for Remicade, Rituxan/MabThera and Herceptin. All these three drugs are blockbuster biologics. While Remicade clocked $6.65 billion for Johnson & Johnson, Herceptin earned close to $6.9 billion for Roche and Rituxan/MabThera brought more than $7.54 in revenues. If biosimilars are approved worldwide, Pfizer could be looking to target a market of more than $15 billion with its phase 3 biosimilars. This assumes that biosimilars will be priced 30% below patented drugs. However, at present, only Europe has an established process to approve biosimilars, though there has just been a single approval in the U.S. As such, the timeframe for approvals is even less clear than normal.   Additionally, we need to consider the evolving competition which may bring the prices further down. In fact, some competitors are offering discounts of as much as 70%.

Overall, we expect Pfizer’s pipeline drugs to bring close to $5-$6 billion over the course of next four years. However, if the company exceeds this expectation, and doubles the revenue from pipeline drugs, it could add approximately 10% to its value. There are reasonable grounds to consider this as a plausible scenario. some of the factors that can fuel this outcome are:  1) the growing market for biosimilars, which could be as big as $20 billion by 2020; 2) the recent acquisition of Hospira (we have not incorporated this in our model yet but will do so once the deal closes); 3) the potential success of Xeljanz and some other phase 3 drugs including a type 2 diabetes drug and possibly a breast cancer drug (phase 3), as well.

R&D Rationalization Fails (-10%)

Pfizer’s adjusted EBITDA plummeted by roughly 17% in 2014 despite only 3.8% decline in revenues. This can be attributed to lower gross margins, higher administrative and marketing expenses, and most importantly, a big jump in research and development spending. This is slightly at odds with what one would expect given the company’s restructuring program to streamline investment. However, some additional spending related to certain drugs in phase 3 trials (which are the most expensive) and the dveopment deal with Merck KGaA weighed on the company’s profits. Under the terms of the deal, Pfizer made an upfront payment of $850 million to Merck KGaA, and promised additional payment of up to $2 billion contingent on regulatory and commercial milestones. [1]

Pfizer needs its pipeline to be productive considering the large number of its drugs the face strong competition, which justifies its increase in R&D expenses. The next year will be different as the company intends to reduce its R&D spending. We expect the figure to be around $7.2 billion (19% of gross profits) as compared to $8.4 billion in 2014. This implies that there may not be any big deals such as the one with Merck KGaA, and we expect the company to cut back on some of its R&D staff as it continues its restructuring program. However, if this rationalization doesn’t yield expected results, the situation can change. Gross profits may continue to decline while Pfizer may have to invest further for innovative therapies. If this pushes its R&D expenditures as percentage of gross profit past 24%, there can be downside of about 10%. This will not only come from increased R&D expenses, but also from reduced gross profits and lower margins.

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Notes:
  1. Pfizer, Germany’s Merck to Develop Tumor Treatment, The Wall Street Journal, Nov 17 2014 []