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The Pfizer Due Diligence Report
Time to get a double dose of Pfizer stock?
Update (8/27/21): Since releasing this report, Pfizer has received full FDA approval for its COVID-19 vaccine. You can read more here.
The Big Picture
The COVID-19 pandemic rocked the world last year. Healthcare companies scrambled to develop a vaccine to help slow down the virus’s spread and pave the way back to normalcy. In November, Pfizer became the first pharmaceutical company to receive vaccine approval from the FDA. More recently, Pfizer announced that its COVID-19 vaccine generated $3.5 billion of revenue in the first three months of 2021. Yet, since the day it received emergency use authorization, Pfizer stock is actually down 2.5%.
Why is that? Is one of the world’s largest pharmaceutical companies somehow not getting enough attention in the midst of a public health crisis?
Or are investors right to be cautious?
Pfizer Inc. (PFE) is a global biopharmaceutical company that’s been around for a while, dating back to its founding in 1849. It discovers, develops, manufactures, markets, distributes, and sells biopharmaceutical products, such as medicines and vaccines. (Since we’re not doctors, we’ve limited medical jargon and kept the science high-level.)
Pfizer sells prescription pharmaceutical products to wholesalers primarily, but it also works directly with retailers, hospitals, clinics, government agencies (like the CDC), and pharmacies. Pfizer's products are known as “brand-name” drugs, like Ibrance, Inlyta and Eliquis — as opposed to “generic” drugs. Brand-name drug manufacturers run clinical trials to test and develop new drugs, often passing on costs to the end-consumer.
Pfizer also makes money from alliance agreements, which are partnerships with other companies to co-develop and co-promote certain drugs. For instance, Pfizer’s COVID-19 vaccine (BNT162b2) was jointly developed and commercialized with BioNTech. Although Pfizer develops many products, seven of them accounted for 53% of total revenue in 2020.
Pfizer's products and operations are divided into six segments:
Inflammation & Immunology
The drug development process is complex and time-consuming. From initial discovery research through clinical trials and regulatory approval, it can take 10+ years to get a drug to market. Here’s the FDA’s verbatim outline of the process:
Discovery and Development: Research for a new drug begins in the laboratory.
Preclinical Research: Drugs undergo laboratory and animal testing to answer basic questions about safety.
Clinical Research: Drugs are tested on people to make sure they are safe and effective.
FDA Review: FDA review teams thoroughly examine all of the submitted data related to the drug or device and make a decision to approve or not to approve it.
FDA Post-Market Safety Monitoring: FDA monitors all drug and device safety once products are available for use by the public.
As of early February 2021, Pfizer had the following number of projects in various stages of R&D:
As a mature and global company, Pfizer’s growth potential isn’t quite at the same level as other stocks we’ve covered. Instead, Pfizer’s advancement is driven by acquisitions and additional drug developments.
Before we jump into the COVID-19 vaccine storyline, we first need to discuss Pfizer’s recent restructuring. In July 2019, Pfizer announced a spin-off of its Upjohn unit, which held notable but aging drugs like Viagra, Lipitor, Chantix, and Lyrica. Once the transaction closed in November 2020, Upjohn merged with Mylan, a generic drugmaker, to form Viatris (VTRS). The company estimates that cost savings as a result of the transaction will be approximately $1 billion.
Upjohn revenues represented 16.5% of Pfizer’s total revenue over the first nine months of 2020, so the divestiture adversely impacts revenue. However, the transaction offered a few benefits, including $12 billion of cash for Pfizer and the opportunity to prioritize a smaller portfolio of innovative drugs and vaccines that offer more long-term potential.
The Upjohn spin-off was not the only major move completed last year; Pfizer combined its over-the-counter medicine business with GlaxoSmithKline’s (GSK) to form a new joint venture (JV) under the name GSK Consumer Healthcare, which is now the largest provider of non-prescription drugs. Although Pfizer owns 32% of the JV, GSK owns the remaining amount and oversees operations.
There are two major plot points to cover:
The vaccine, which is what led us to cover Pfizer in the first place.
In December 2020, the FDA authorized the distribution and emergency use of Pfizer’s and BioNTech’s BNT162b2 vaccine for individuals 16 years of age and older. Pfizer then received authorization from numerous countries all over the world, enabling it to enter agreements to deliver doses of the vaccine.
While major pharmaceutical companies like AstraZeneca and Johnson & Johnson said they’d forgo profits to develop a COVID-19 vaccine, Pfizer and Moderna said, “Screw that.” Pfizer would not promise to sell its vaccine at cost.
Morals aside, that proved to be a financially beneficial decision. As of this month, Pfizer projects $26 billion of COVID-19 vaccine revenue in 2021, which is 36% of its estimated total revenue for the year. The financial windfalls don’t stop there — Pfizer already has contracts in place to supply doses for the next several years. For instance, Pfizer has an agreement to supply Canada with 125 million doses in 2022 and 2023, with the option for more in 2024. (Note that Pfizer splits gross margin derived from BNT162b2 evenly with BioNTech.)
The question isn’t whether the vaccine is profitable for Pfizer (it is), it’s how long will it be profitable? Many are treating the company’s vaccine fortunes as a one-time inflow. However, what if COVID-19 vaccines become an annual necessity like the flu shot? Pfizer’s CEO, Albert Bourla, says it's likely — but we think he might be a little biased.
We also have to consider another recent development: there’s international pressure to waive patent rights so that less developed countries can manufacture and distribute the vaccine too. But that’s a bold move with potentially massive ramifications. Within a LinkedIn post addressing the patent waiver, Bourla made the following statement:
“It will unleash a scramble for the critical inputs we require in order to make a safe and effective vaccine. Entities with little or no experience in manufacturing vaccines are likely to chase the very raw materials we require to scale our production, putting the safety and security of all at risk.”
The United States spends the most on health care — and it’s not even close. One study found that the US spends $8,047 per capita on public health. The next four closest countries spend closer to $5,000 per capita. Drug prices contribute to that astronomical metric — which is why they’re a major political talking point. This is a controversial aspect of pharmaceuticals, specifically “Big Pharma.” Each year, pharmaceutical companies face questions about price gouging (i.e. the practice of unreasonably raising the price of a product or service).
Researching and developing drugs is an expensive process. So, raising drug prices and passing costs onto the consumer isn’t totally unjustifiable. That is, until you look at how much pharmaceutical companies spend on drug development compared to marketing. Because Big Pharma spends a lot of money on marketing.
It’s an industry standard to roll marketing and advertising expenses into a line item called Selling, Informational, and Administrative (SIA) expenses. Per the company’s annual filing, SIA expenses include costs related to marketing, advertising, shipping and handling, information technology, and legal defense.
In FY20, Pfizer spent $11.6 billion on SIA expenses compared to $9.4 billion of R&D expenses. While Pfizer doesn’t specify marketing spend, it did share that advertising expenses were $1.8 billion in 2020 — compared to $2.4 billion in 2019 and $2.7 billion in 2018.
Long story short, Pfizer faces ongoing risks related to pricing pressures. If domestic and/or international governments control prices or limit patient access to certain products, Pfizer’s operations would be adversely impacted.
The pharmaceutical business is quite competitive, but Pfizer is in the upper tier of the industry in terms of operating results and market capitalization.
Although Pfizer appears to trade at a significant discount, the company’s outstanding shares dwarfs its competitors (more on this later). This also lowers the impact of trading volume and EPS results.
The High-Level Finances
Note that we’ve illustrated post-restructuring, restated results; all dollar amounts are illustrated in millions.
When accounting for the 2020 restructuring transactions, Pfizer’s annual revenue has remained relatively consistent over the last three years. That’s bound to change in FY21 thanks to the widespread distribution of Pfizer’s COVID-19 vaccine. Pfizer has upped revenue guidance for the year to somewhere between $70.5 to $72.5 billion, which would represent a 68 to 72% increase compared to FY20.
Needless to say, there’s a lot of time left in 2021 — but Pfizer’s agreements to deliver set amounts of vaccine doses provide some transparency/certainty around their estimates.
EBITDA (earnings before interest, taxes, depreciation, and amortization) is a metric used to gauge a company’s operating performance. A company’s operations can appear worse due to certain non-cash expenses, such as depreciation and amortization. We’ve illustrated our calculation of Pfizer’s EBITDA (they don’t calculate an adjusted EBITDA).
Pfizer recognized a gain for the GSK joint venture transaction in 2019, which is the primary driver of FY19’s EBITDA increase.
We know what you’re thinking: How on earth does Pfizer’s EBITDA nearly match its net income? Pfizer’s discontinued operations, which we did not include within its EBITDA calculation, flow through net income. Regardless, Pfizer’s first quarter results are more telling.
The relative increase was primarily driven by (a) the vaccine’s initial distribution, (b) Eliquis’s growth around the world (up 25% operationally), and (c) Vyndaqel’s/Vyndamax’s growth (up 88% operationally).
The Primary Strengths
Vaccine profits. It’s a good time to be in the vaccine business — and it’s even better when you can claim the title of “first COVID-19 vaccine” distributor. Despite spinning off its Upjohn unit in FY20, Pfizer should see a major revenue boost in FY21. That’s more money for R&D (and marketing), which means additional drug developments and rollouts.
Everything else still profits. Although the average person will forever recognize Pfizer for its vaccine efforts, it’s still a massive pharmaceutical company with products spanning multiple healthcare segments. Excluding BNT162b22 results, Pfizer still experienced revenue growth of 8% in the first quarter of 2021 compared to the same quarter last year.
New drugs and pipeline. Over the last few years, Pfizer received approval for several treatments and medicines; for example, cancer medicines like Lorbrena and Daurismo could boost oncology-related revenue. In addition, Pfizer’s drug development success rates exceed industry averages; for example, the company’s five-year rolling average phase III success rate has improved from 70% to 85%.
The Primary Risks
Regulation and price pressures. Pfizer’s products are subject to government regulations and public scrutiny. If governing bodies — particularly in the U.S. — force Pfizer to reduce prices, that would be bad for business.
Generic competition. Pfizer and other name-brand manufacturers are charged with developing novel and innovative drugs. In turn, they gain market exclusivity for certain periods of time (depending on the type of exclusivity). After that, generic manufacturers join the party. Loss of exclusivities (LOES) are expected to hurt 2021 revenue by approximately $1 billion. (Also, any regulatory efforts intended to limit these exclusivity periods would be bad for business too.)
Growth limitations. By growth, we’re not referring to revenue or acquisitions or anything of that nature. Instead, we mean share price appreciation. This isn’t an operational risk, but it is worth mentioning. With 5.6 billion outstanding shares, Pfizer’s share float is gargantuan, meaning it would take a very high volume of sustained buying or selling to move its share price. Pfizer has more than twice as many outstanding shares as Merck and Johnson & Johnson (2.5 billion and 2.6 billion, respectively). Pfizer’s history of dividend payouts partially offsets the stock’s limited ceiling.
The Street’s Opinion
22 analysts issued ratings for Pfizer. Most analysts (16) currently rate PFE as a “Hold.” However, there are a handful of optimistic analysts with four “Buy” ratings and one “Overweight” rating.
The average price target ($42.23) is relatively in line with the stock’s current price of $40.10.
Time to get a double dose of Pfizer stock?
Big Pharma isn’t the most well-regarded industry, especially in the US where health care costs are ridiculously high. However, from an investor perspective, pharmaceutical companies generate money hand over fist, and often share these earnings with shareholders. The COVID-19 vaccine amplifies the situation. Although Pfizer was a successful, high-earning company before, its COVID-19 vaccine is supplying a fresh surge of financial tailwinds.
Of course, none of that is a secret. So, why are PFE’s returns lagging behind? Regulatory pressures and uncertainty, as well as a high quantity of outstanding shares.
Holistically, drug price reform is a foreboding obstacle looming on the horizon, but — as with any bureaucratic process — it doesn’t look immediate. For the vaccine, Pfizer has already entered into a number of agreements to deliver hundreds of millions of doses to countries all over the world. So, there’s some transparency there, at least.
Pfizer’s share float suppresses price movement volatility — which can be good or bad depending on your investment goals. And that doesn’t look like it’ll change any time soon, as Pfizer halted its share repurchase program after 2019.
At the end of the day, Pfizer seems like a relatively safe long-term play.
Keep an eye on (1) anything regarding COVID-19 vaccines (particularly distribution agreements and regulation), (2) new drug developments for Pfizer, and (3) broader drug price reform, which would majorly impact Pfizer’s earnings.