Pfizer's Bear's Rebuttal
by Louis Corrigan [email protected]

Pauly makes a strong case for Pfizer as a great company, a "Blue Chip plus Growth" stock that deserves a premium valuation. Of course, the trailing earnings reflect zippo in the way of Viagra sales. Second quarter results are sure to be pumped up significantly. And who's to say we won't all be downing Viagra in our cereal someday. The possibilities are endless. Viagra could be such a monster drug that even Godzilla will look puny by comparison. The company also spends a ton of money on R&D, giving it perhaps the strongest new product pipeline in the pharmaceutical industry.

Of course, not all new products are simply accretive. While Pauly lumps the antihypertension drugs Norvasc and Procardia together as cash cows, milk from one is coming at the expense of the other. Norvasc sales grew 14% in the first quarter, even as Procardia sales dipped 19%. Pfizer is promoting the new product at the expense of the old one.

Also, recent results have not been as terrific as they first seem. Pfizer's soaring gross margins (81.8% last year versus 78.4% in FY95) have been due to higher-margin pharmaceutical sales becoming an increasingly dominant chunk of the sales mix. But marketing and R&D expenses have risen at close to the same pace. As a result, operating margins actually declined slightly last year to 24.7% from 24.8% in FY96. That means net margins would have fallen were it not for the significantly lower tax rate (28% versus 31% in FY96). So much for that five-year history of growing profit margins.

At the same time, topline growth in the pharmaceutical segment has also been decelerating, from 21% in FY94 to 15% in FY96 and 11% in FY97. New product introductions such as Viagra will no doubt reverse this trend, but it still is a trend. It's just silly to ignore the fact that Pfizer's stock has soared even as its recent results show the existing business (sans hot new product launches) topping out.

The question is, how do we value that super future growth from new products such as Viagra? Where Pauly's analysis is weakest (indeed, silent) is on this question of valuation. He doesn't give us any numbers to consider, which suggests to me that he knows he can't win this duel on the merits. After all, it's possible to agree with nearly everything my fellow Fool has said and still see Pfizer as a poor investment.

I'm assuming the analysts' high side number (EPS of $2.90 for FY99; the consensus is just $2.55) includes all the expected positive results from Viagra plus Pfizer's other new offerings. That estimate assumes 65% EPS growth over the next seven quarters, or 33% annualized earnings growth over this period. That's nearly twice the 17.8% annual rate seen over the last three years. So, the stock now trades around 37 times next year's earnings. That means Pfizer isn't just pricey relative to trailing results, it's pricey relative to the most optimistic results going two years out.

Given that it's unlikely that Pfizer can continue to grow at 33% a year indefinitely, it's very possible that the current price discounts the company's results well into the next century. In other words, without some even more spectacular surprises on the Viagra front, Pfizer could simply be dead money for the foreseeable future. Great company, bad investment.

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