Why Pfizer, Lilly Are Both Buys
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the last few months, large BioPharma has been through a rocky period where investors are starting to feel anxiety over patent cliffs. The exclusivity loss to Lipitor was very much a wet blanket to not only Pfizer (NYSE: PFE) shareholders but to the industry at large. Sure, the generic market benefits, but it emphasized what many healthcare investors don't want to here: Intellectual property has its theoretical limits. With that now said, let's turn to assessing the fundamentals of Pfizer and peer Eli Lilly (NYSE: LLY).
Pfizer trades at a respective 21.1x and 10.5x past and forward earnings with a dividend yield of 3.6%. Analysts forecast 2.1% annual EPS growth over the next five years, which I believe is incredibly bearish. This sets the bar low for high risk-adjusted returns.
If you look at Pfizer's catalysts, there are multiple areas to be optimistic about. Tofacitinib is looking like it will be a blockbuster drug approved on November 21. The FDA Arthritis Advisory Committee has already overwhelmingly ruled in favor of the candidate. Phase III data revealed that a majority of patients achieved a clinical improvement in symptom through both the 5mg and 10mg dosing. This drug would be the first FDA-approved solution for arthritis via Janus kinase inhibitors and oral administration.
Perhaps most importantly, it is odd that the firm is only valued at slightly above 10x forward earnings when the historical PE multiple is 16x. This gives the stock much more of an upside case than down. Free cash flow supports the compelling value story at the same time. FCF for the TTM ending 2Q12 was $14.9 billion - solid for a challenging time period. Results have been better than many expected while the dividend yield continues to provide a steady state of income.
Eli Lilly is another compelling buying opportunity. It trades at a respective 12.9x and 12.4x past and forward earnings with a dividend yield of 4.2%. Analysts are nevertheless bearish on the stock, project an 8.2% annual earnings decline over the next five years, and rate the stock closer to a "sell" than a "buy." Even still, the stock has more or less consistently hovered upwards through 2012 and gained 12.3% in value.
The company has also generated solid returns. It has beaten expectations in the last three quarters by an average of 11.1%. Again, too much attention is being put on patent cliffs and not enough on the firm's valuable brand, defensive capital allocation policy, and promising pipeline.
In regard to that third category (promising pipeline), Eli Lilly is more skewed towards reward than risk. Although the Phase III trial for Pointbreak did not meet the primary endpoint in improving lung cancer survival, it was successful in improving progression-free survival to Alimta. After the fall of Pfizer and Johnson & Johnson's bapi, it should not be surprising that hope over solanezumab will keep multiples from shrinking. Although the data has not been as promising with what little is available, not much positive has been factored in. The BACE inhibitor for AD also hold potential. I thus recommend buying shares on this defensive income play.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.