Pfizer (NYSE:PFE) stock is cheap. About that, there’s little doubt.
Based on 2021 analyst estimates, PFE stock trades at less than 13x earnings. In a market that trades at all-time highs, and where valuation concerns are running rampant, that seems to be an extraordinarily low multiple.
The question, however, is why Pfizer stock seems so cheap. And the answer seems to be based on very real concerns about the Pfizer business.
Those concerns have been around for a while now, a key reason why PFE stock has underperformed the market. Including dividends, the stock has returned a solid 9% annually over the past five years. To be fair, for a defensive name like Pfizer, that underperformance isn’t a surprise. Still, investors have done better elsewhere.
Compressing the time period, however, the returns get worse. Over three years, PFE has returned just less than 6% annually. (To be fair, shareholders who kept their stakes in Viatris (NASDAQ:VTRS), spun off and merged with Mylan, are doing a bit better.) Taking the broad view, shares still trade below late 1990s and early 2000s peaks.
Back then, Pfizer was a powerhouse, thanks to record-setting drugs like Viagra for erectile dysfunction and cholesterol treatment Lipitor. The question, and the concern, is what Pfizer is now.
Smaller and Nimbler
The bigger move came last year. It merged its generics business with Mylan to create Viatris.
Investors didn’t particularly like either deal, particularly the tie-up with Mylan. But the broader strategy makes some sense. A smaller, nimbler company should be able to drive faster growth. And it’s been a lack of growth that’s likely hurt PFE stock in recent years. Revenue actually declined between 2016 and 2019, even excluding discontinued operations.
We’ve seen similar strategies elsewhere in the market. General Electric (NYSE:GE) actually is an interesting comparison. GE certainly had more pressing balance sheet issues (notably on the pension front) to contend with than does Pfizer. GE was more aggressive in its divestitures as well.
But both companies were in relatively similar positions: old-line giants that needed to adapt to changing industries. Both stocks underperformed. In fact, both were removed from the 30-stock Dow Jones Industrial Average (GE in 2018 and Pfizer this year).
Both companies saw a strategy of downsizing as the appropriate response. For Pfizer, that strategy should allow the company to focus on developing new drugs rather than monetizing former blockbusters or dealing with a consumer business. It will also concentrate the company in faster-growing end markets, with many low- and even negative-growth products divested in the spinoffs. That should grab investor attention.
The New Pfizer
The plan makes sense. But that doesn’t necessarily mean it will work.
Indeed, one of the near- to mid-term worries is that when these stories end, the stock lacks a catalyst. GE is instructive on this point. There’s not much left for that conglomerate to do, leaving the company reliant on more modest, organic improvements that are less likely draw investor eyes. While GE stock rallied of late, it’s still gained less than 5% since Larry Culp took over as chief executive officer more than two years ago.
Pfizer now is at a similar point. PFE stock is going to rally from here based on the company’s ability to become a leader in drug development. The problem is that historically that hasn’t been Pfizer’s strong suit, as Barron’s noted in late 2019.
Obviously, Pfizer has one huge success with its novel coronavirus vaccine developed in conjunction with BioNTech SE (NASDAQ:BNTX). It’s a good step, and a good sign.
But Pfizer still has a market capitalization over $200 billion. Even big success with the vaccine isn’t going to move the needle from a profit or valuation standpoint. Pfizer, simply put, needs more, and investors seem to have figured that out. A solid rally in PFE stock around November on the back of positive vaccine news has almost completely reversed.
The Case for PFE Stock
This is not to say that PFE stock should be sold short, or sold at all. Pfizer remains a pharmaceutical giant. Its dividend yields 4.2%. Valuation, as noted, is relatively reasonable.
But there are risks. The divestitures of consumer and generic products put more focus on the always-uncertain business of drug development. Pfizer’s pipeline is diversified, but not guaranteed to have another blockbuster. There’s even a case that blockbusters themselves are increasingly difficult to find, with so many of the most profitable indications already targeted.
Investors simply need to calibrate their expectations properly. Yes, PFE stock looks cheap relative to the market, but large-cap pharma stocks always do, given the constant cycle of patent expiration. Merck (NYSE:MRK) also trades at 13x forward earnings. Bristol-Myers Squibb (NYSE:BMY) is at 8.4x, in large part due to looming exclusivity losses at recent acquisition Celgene.
There likely is some upside here. The dividend is safe. The sector as a whole rallied of late after years of modest returns. Political risks seem overblown in the context of an industry that has proven incredibly successful at lobbying politicians and regulators (at least in the U.S.)
But broadly speaking, there are reasons why Pfizer stock looks so cheap. And, as with any stock, there are risks. Pfizer as a company looks much different than it did two years ago, but I’m not convinced that’s true of Pfizer as a stock.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.