Is Bigger Better When it Comes to Big Pharma?

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The demand for drugs worldwide is expected to increase due to emerging markets abroad and more specifically, due to an influx of demand from the aging "Baby Boomers" domestically. Many pharmaceutical companies are poised to benefit, especially the ones with strong drug line-ups. The company I currently like the most in the "Big Pharma" sector is Pfizer (NYSE: PFE), and here are 3 reasons why.

1.) It's the biggest player in town...

Pfizer is the largest research-based pharmaceutical company in the world. Besides being the largest, the company also sports a relatively strong balance sheet with an increasing emphasis on cash:

Pfizer also has a strong portfolio consisting of popular brand name drugs such as Zoloft, Lipitor, Viagra, etc. The company also offers popular consumer products, such as Chapstick.

2.) It's trading at a discount to peers...

Pfizer seems to be discounted to peers such as Merck (NYSE: MRK), Eli Lilly (NYSE: LLY), Bristol-Myers Squibb (NYSE: BMY), and Johnson & Johnson (NYSE: JNJ)

 P/EForward P/EDividend (Yield)Market Cap (billions)
PFE 14.44 11.87 0.96 (3.40%) $201.44
MRK 22.05 11.6 1.72 (3.90%) $133.26
LLY 15.06 19.69 1.96 (3.60%) $60.29
BMY 33.59 17.95 1.40 (3.60%) $63.79
JNJ 20.52 13.75 2.44 (3.10%) $221.36

The company not only has the lowest trailing P/E ratio, but also carries one of the lowest P/Es going forward. Throw in a competitive dividend, and it looks like Mr. Market is offering a bargain for investors. Not only that, Pfizer also currently trumps its peers in generating free cash flow as well:

3.) Emerging markets are an opportunity for growth...

Emerging markets made up a good amount of the company's revenue in 2012:


Courtesy of Statista

Increasing sales in growing and emerging markets should provide the opportunity for sustainable future growth. That said, nothing is for certain and no company is bulletproof.

And now, the bad news...

Like all pharmaceutical companies, Pfizer relies on patents to protect its signature products. When these patents expire, cheaper generics begin to eat away at these previous blockbuster cash-cows. For instance, largely as a result of the expiration of patents for one of its main moneymakers, cholesterol drug Lipitor, Pfizer experienced a 10% decrease in revenue last year.

Revenue may continue to slide this year as well, and it is imperative that the company continues to fund research and keep funding to support a strong pipeline of new drugs. Pfizer is not alone, either.

Bristol-Myers knows what it's like to feel nervous over key patent loss as well. The company is facing the loss of patents for key moneymakers such as Plavix, which has already seen a 65% drop in sales from intense competition from generics, according to Forbes. The company's Baraclude drug, worth over a billion dollars, is also being attacked sooner than expected, after a Delaware court invalidated patents related to the Hepatitis B drug.

Generics will continue to be an ongoing concern for many. Eli Lilly is still looking to replace revenue that will be lost to generics, now that its Zyprexa drug has lost exclusivety in the U.S. and Europe. The company is also scheduled to lose more patents in the latter part of the year for one of its key drugs, Cymbalta, as well as its Evista drug's patents in 2014. 

Not everything is lost for Pfizer after Lipitor, however, as the company managed to get an extension on its pain-related drug, Celebrex, which gives the company exclusive rights until 2015. Celebrex is a multi-billion dollar drug, so retaining exclusivity and keeping it out of the clutches of generic producers is great news for Pfizer. Keeping Celebrex exclusive was a big win, but the company will continue to be on the edge of the patent cliff and will need to keep its pipeline of future drugs strong to survive, and continue to successfully skirt the cliff. 

Lawsuits from products that backfire, and act otherwise than improving ones health, are also concerns for many drug companies. Rival Johnson & Johnson is beginning to feel the heat from numerous lawsuits stemming from complications caused by their transvaginal mesh implant product. Over $11 million against the company and its Ethicon subsidiary has been awarded, and the pain for Johnson & Johnson may continue for some time.

Merck is no stranger to lawsuits either. The company agreed to settle a class action lawsuit for $39 million back in November. The company may also see further financial damage, after a judge recently approved a $220 million settlement related to the company's painkiller drug, Vioxx. This seems less painful than Johnson & Johnson's potential lawsuits, however, which total over 10,000 so far. Lawsuits can be very pesky to big pharma's profits.

The bottom line

It looks like Pfizer offers lot of value at current levels. It looks cheap in comparison to peers, and is strong financially. The company (with the exception of Johnson & Johnson) also dwarfs competitors in market cap. An investor in Pfizer will, however, need to keep a watchful eye on the company's patent portfolio, as the expiration and loss of exclusivity of a main moneymaking drug can significantly effect the company's top and bottom lines. Competitors face a similar dilemma.

Aging Baby Boomers will demand more drugs, and the largest maker of drugs should benefit as long as the current products are protected by patents and the pipeline is strong. While emerging markets provide tons of growth, they also have their hiccups. Recent patent-related arguments have surfaced in India between its government and Pfizer, with the company's Roy Waldron stating that, "India has essentially created a protectionist regime that harms U.S. job creators" after patents related to cancer medication were revoked.

The company still has a large and diversified portfolio of winning drugs that should help it sustain its current moat. The breadth and depth of its portfolio is hard to duplicate. The company also has a large cash horde for funding and research, or even buying out smaller drug makers to expand and grow. All potential risks aside, Pfizer makes a good value play and its dividend of 3.60% pays investors handsomely. 


Joseph Harry owns shares of Pfizer. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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