Benylin

Patented Profits

Pfizer has grown both its revenues and EPS at unusually high rates, with consistency, for the last ten years. Surprisingly, the PIE multiple on the stock has ranged as high as 70 times EPS (in 1998) to a current multiple in the 25 - 35 range.

With such stocks there is always the risk of a sharp drop in the multiple - and share price - arising from a surprising decline in either the company's revenue or EPS growth, or, in the general stock market. To minimize this risk, prudent investors who might consider purchasing the stock should consider the merits of using a series of modest purchases spread out over several months, quarters and even years - rather than a single large purchase. Editor

Pfizer develops, manufactures, and markets prescription medicines such as anti-cholesterol, antidepressant, antibiotic, anti-diabetic drugs and hypertension regulators. Pfizer also has widely recognized consumer products sold under brand names such as Visine, Ben-Gay, Halls, Trident and Clorets.

Historical & Future Growth Prospects

Over the longer term, a stock's price only goes up 'a lot' if the company's revenues and earnings go up 'a lot.' So, let's start our study of the potential growth in Pfizer's share price by understanding the reasons for its historical revenue growth and the prospects for it continuing over at least the next five years.

The Numbers

As indicated by the historical Revenue Profile (opposite page), since 1991 revenue growth has averaged about 17% per year. During the last half of the study period, growth accelerated to about 26%. However, for the first nine months of fiscal 2001, revenues were up only 9%. Estimated fiscal 2001 revenues are $32 billion - 8% greater than fiscal 2000.

Important Products

Pfizer relies on two main product groupings to generate its revenue growth: (1) human and animal pharmaceuticals; and, (2) consumer products.

Pharmaceuticals (81% of estimated 2001 revenues vs. 96% in 1996)

* Human Pharmaceuticals (77% of revenue) include such products as: Lipitor (an anti-cholesterol drug representing 17% of total revenue); Norvasc (hypertension and angina, 11 %); Zoloft (anti-depression, 7%); Zithromax (antibiotic, 5%); Viagra (erectile dysfunction, 5%). These, and three other leading drugs, represent nearly three-quarters of revenues from human pharmaceuticals.

* Animal Pharmaceuticals (4% of revenue) includes anti-inflammatoties, anti-parasitics, vaccines, and anti-infectives for `companion animals' and livestock.

Consumer products (19% vs. 4%) Pfizer's consumer products include highly-recognized brands such as Listerine (mouthwash), Benadryl (antihistamine), Zantac (anti-heartburn), Rolaids (antacid), Benylin (cough products), Efferdent (denture cleanser), and Neosporin (antibiotic ointment).

The company also sells confectionery products like Halls, Dentyne, Trident, Certs, and Clorets.

Important Markets

Products are sold in the following regions: United States (61 % of revenues); Europe (20%); Japan (7%); and, other countries (12%).

Important Customers

Human pharmaceuticals are marketed to key healthcare providers, such as doctors, nurses, pharmacists, hospitals, pharmacy benefit managers, managed-care organizations, and, directly to consumers through print and television media.

Some 35% of revenue comes from three wholesalers in the pharmaceuticals segment (13% from McKesson HBOC, 11% from Cardinal Health and 9% from Bergen Brunswig). Apart from these, no business segment is overly dependent on any one customer.

Consumer products are sold through retailers and are heavily advertised.

Animal health products are sold through veterinarians, drug wholesalers, distributors, retail outlets and directly to users.

Important Competitors

The company's principal competitors include global pharmaceutical companies such as Merck (MRK:NYSE), Bristol-Myers Squibb (BMY:NYSE), Eli Lilly (LLY:NYSE) and GlaxoSmithKline PLC (GSK:NYSE).

Important Influences on Future Revenue Growth

Demographics. Future growth in the demand for Pfizer's drugs is expected to come from the `demographic bubble' of aging baby boomers who increasingly require drug treatments.

In anticipation of this growing market the company's existing portfolio of drugs is specifically targeted at diseases associated principally with aging; namely, Lipitor for cholesterol, Norvasc for high blood pressure, Procardia XL for angina, Aricept for mild Alzheimer's, Celebrex for arthritic pain, and Viagra for impotence.

Patents. As with all drug companies, competition from generic drug manufacturers is a major consideration when patents* expire. However, Pfizer does not expect serious patent-expiration problems in the near future. For example, the U.S. patents for Lipitor (17% of revenue) expires in 2010, Norvasc (11%) expires in 2006, Zoloft (7%) in 2005 and, Zithromax (5%) in 2005.

Pipeline. Future growth is also expected to come from Pfizer's new-product research and development ("R&D"). With an estimated R&D investment of $4.8 billion in 2001 (15% of revenue) the company expects to continue developing new drugs such as:

(1) Geodon (an anti-psychotic drug for treating schizophrenia) to compete with Eli Lilly's Zyprexa - Geodon has a lower incidence of side effects (in particular, a lower incidence of weight gain); and,

(2) Spiriva which is used to treat chronic obstructive pulmonary disease and which is expected to generate about $1 billion in annual sales after its launch in 2002.

Core Standards. Also, recently announced new guidelines for managing cholesterol levels are expected to potentially double the market for cholesterolreducing drugs. Since Pfizer's Lipitor already has a 44% share of this market, the company expects to benefit significantly from the anticipated increase in demand.

New Applications. Pfizer also expects to increase sales through product management (e.g. developing new applications for existing drugs). For instance, the company's anti-depression drug Zoloft is now also approved for longterm treatment of post-traumatic stress disorder and anxiety.

Capacity to Grow Revenues

Generally, a company's revenue growth is made possible by growth in its assets. Since 1991, Pfizer's total assets have grown from about $10 billion to an estimated $41 billion in 2001.

About $22 billion of this asset expansion resulted from earnings retention (Chart 1). Another $8 billion came from spontaneous increases in shortterm liabilities, with the remainder from long-term debt and other liabilities.

Expanding assets with this financing mix has reduced the company's reliance on debt from about $61 of debt for every $100 of equity in 1991 to $42 estimated for 2001 (see Chart 2).

Chart 3 illustrates that Pfizer's efficiency in generating revenues from assets has generally increased throughout the study period from about $86 of revenue for every $100 of assets in 1991 to an estimated $100 in 2001.

Projected Revenue Growth

Here, an illustrative ID judgment was made to grow revenues at an average annual rate of about 12% to approximately $56 billion by 2006. This growth rate is supported by: (1) consistent, historical growth averaging about 17% since 1991; (2) the company's current product line that is insulated from generic competition for several years; and, (3) the expectation that, over the next three to five years, the company will continue developing new drugs to further increase sales.

Capacity to Grow EPS

Historical EPS Growth

As indicated by the accompanying historical EPS Profile (before discontinued, extraordinary and special items), since 1991 growth has averaged about 19%. During the last half of the study period growth increased to about 22%. For the first nine months of fiscal 2001, EPS were up about 29%, with fiscal 2001 EPS estimated at $1.31 or about 27% greater than last year.

As indicated by the accompanying Profiles, EPS growth has generally exceeded revenue growth. Such growth is attributed to the steady increase in Pfizer's efficiency in converting revenues into earnings. Chart 4 shows this efficiency increasing from about $13 of net earnings for every $100 of revenues in 1991 to approximately $26 in 2001.

Projected EPS Growth

The fundamentals driving Pfizer's future revenue growth and the company's increasingly efficient conversion of revenues to earnings support a judgment that future EPS growth will continue to exceed revenue growth. Accordingly, an illustrative 0 judgment was made to grow EPS at about 20% to approximately $3.26 by 2006.

Is the Stock "On Sale" or Over-Priced?

Historical Prices

Chart 5 illustrates the relationship between growth in Pfizer's earnings and growth in its share price throughout the study period. However, early in the study period (1992-1994), growth in share price lagged EPS growth (indicating under-pricing) while later, price growth got ahead of EPS growth (indicating over-pricing). Since then, the company's price has `gone flat' while waiting for earnings to `catch up'.

The recent price of about $42 falls in close proximity to the projected EPS Profile for the next five years (reflecting growth at 20%) which suggests that the stock is currently `fairly-priced.'

Section 2 of the Guide indicates a Relative Price Earnings Ratio of 0.86, which suggests that the Recent Price for $1 of projected EPS - namely $26.70 (the Recent P/E Ratio) - is some 14% lower than the average historical price paid for the company's earnings.

Future Prices

For illustrative purposes an 0 judgment was made to expect investors in 2006 to be willing to pay about $30 for each $1 of Pfizer's earnings (the average price paid for $1 of EPS during the study period was $31). This Upside PIE judgment in combination with projected EPS of $3.26, results in an Upside Price of $97.80 in 2006. A move to this level from the Recent Price would provide shareowners with a compound rate of return (including dividends) of about 20%.

Consequently, Pfizer's Recent Price is low enough to provide investors with about 5 to 6 times the return currently available from risk-free, 5-year GICs or federal government bonds.

Risk

An illustrative (A) judgment was made to expect 'normal' market volatility to possibly take the stock's price down by 20% in the future to about the $34 level. This risk of about $8, and the potential Reward of about $56, produce an attractive 7:1 Reward-to-Risk Ratio.

Summary

All of the foregoing (A) judgments interact to produce a current "Buy Zone" for the stock of $33.60 to $55.00.

Alternative Judgments

Readers should always develop sets of alternative judgments about future growth and pricing when studying a stock. Here, illustrative (B) judgments have: Revenue and EPS growth slowing to 5% and 10% respectively; the P/E ratio declining to 20; and, market volatility taking the recent price down 30% to about $30. These 0 judgments result in a 1.7% rate of return and a `Sell Zone' of $37.93 to $42.20.

*Patent - The exclusive right to use documented intellectual property in producing or selling a particular product or using a process for a designated period of time.

FOR MORE INFORMATION ABOUT PFIZER, CONTACT YOUR INVESTMENT ADVISOR AND/OR PFIZER INC. 235 EAST 42ND STREET NEw YORK, NY 10017 PHONE: (212) 573-2323 OR WWW.PFIZER.COM

Copyright Canadian Shareowner Magazine Inc. Jan/Feb 2002
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