Which Pharmaceutical Giant Is the Best Investment?

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

Amid sluggish sales growth, the Pharmaceutical Industry giants are struggling with declining revenues and profits. Banking on the introduction of new blockbuster drugs and securing new FDA approvals is essential for survival in the industry. In the following article I aim to analyze how Pfizer (NYSE: PFE) and Merck (NYSE: MRK) are catering to the changing industry dynamics, with Novartis (NYSE: NVS) taking the lead.

Recent Events:

Lower overall costs, improved performance and fiscal discipline have helped Pfizer to increase its profits by 53%, during the first quarter. Revenues from Emerging Markets grew 6%, with emerging markets accounting for 20% of the total sales. However, Pfizer’s revenue dropped by 9% quarter-over-quarter, due to loss of exclusivity on various products for instance patent expiration on blockbuster drugs like Lipitor and Viagra coupled with slower than expected sales growth of two of its new top pills.

Pfizer has been aggressively pursuing share buybacks, with recently announcing a $10 billion share repurchase in exchange for its equity in Zoetis (NYSE: ZTC), hence completely spinning off its Animal health care business. Furthermore, the company aims to divest all of its non-pharmaceutical and generic drug business in order to focus on its core prescription drug business, which has far higher profits.

For Novartis,2% surge in sales resulted in a year-over-year increase of 7% in its net income. Growth products (products with patent lasting up till 2017 in key markets such as US, EU and Japan) grew by 14%, contributing a total of 30% to the net sales. Growth in net income is attributable to surge in the growth rates of growth products, accelerated growth of emerging markets by 9% coupled with cost reductions

Additionally, Serelaxin, a heart drug gets the status of a breakthrough drug by FDA, which would potentially rake as much as 2.5 billion dollars in annual sales. However, the company has been able to secure 8 key approvals for drugs in its pipeline across the pharmaceutical divisions, which is responsible for more than half of its sales. Along with that the Novartis is filing NDAs for several existing drugs to extend their uses in other indications. Moreover, it has secured 2 drug approvals in China. One of which is Galvus, used to treat Type II diabetes, considering China has the largest population of diabetic patients reaching 75 million this year. 

Merck in its latest quarterly report reported a 9% decline in its sales, attributable to patent expiry on block buster drugs such as Singulair, Clarinex and Maxalt. Due intense competition from generic drug business, the company’s net income took a hit of 8.3%. Moreover, Januvia, a drug which has always posted double digit gains ever since it has gone on sale, decline by 4% this quarter.

The pharmaceutical division accounts for 83% of the total sales for the company; hence the company is heavily exposed to lower sales and revenues, since Merck is suffering from patent expiry of several major drugs. On the other side, Merck is buying back $15 billion worth of its shares to supports it’s earning amid pressure on its sales; helping Merck to execute and achieve its EPS targets. 


<table> <thead></thead> <thead> <tr><th> <p><strong>Indicator</strong></p> </th><th> <p><strong>Pfizer</strong></p> </th><th> <p><strong>Novartis</strong></p> </th><th> <p><strong>Merck</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Price/Earnings TTM</p> </td> <td> <p>20.3</p> </td> <td> <p>18.7</p> </td> <td> <p>24.6</p> </td> </tr> <tr> <td> <p>Price/book</p> </td> <td> <p>2.5</p> </td> <td> <p>2.7</p> </td> <td> <p>2.8</p> </td> </tr> <tr> <td> <p>Revenue Growth (3 Yr. average)</p> </td> <td> <p>5.7</p> </td> <td> <p>8.5</p> </td> <td> <p>19.9</p> </td> </tr> <tr> <td> <p>Net Income Growth (3 Yr. average)</p> </td> <td> <p>19.1</p> </td> <td> <p>4.2</p> </td> <td> <p>-21.8</p> </td> </tr> <tr> <td> <p>Return on Equity</p> </td> <td> <p>18.8</p> </td> <td> <p>14.8</p> </td> <td> <p>11.2</p> </td> </tr> <tr> <td> <p>Dividend Yield, %</p> </td> <td> <p>3.19%</p> </td> <td> <p>3.44%</p> </td> <td> <p>3.52%</p> </td> </tr> <tr> <td> <p>Current Price</p> </td> <td> <p>$28.81</p> </td> <td> <p>$73.65</p> </td> <td> <p>$48.54</p> </td> </tr> </tbody> </table>

Data from Morningstar on July 13th, 2013

Novartis offers the 2nd highest dividend yield among the three rivals. Over the course of past 10 years, the dividends offered by Novartis have been increasing with a very discreet ratio; due to increase in sales coupled with large amount of Free Cash Flow. Merck on the other hand has provided a flat dividend yield over the year, on contrary dividend yield for Pfizer has cut back on its dividend yield after 2010, in the wake of decline in sales due to patent expiration.

Pfizer outperforms in terms of net income growth over the period last 3 years, which is due to its large scale and diversified portfolio. On contrary Merck has a negative income growth in the face of massive decrease in its revenues this quarter, due to declining sales of its two blockbuster drugs, namely Singulair and Januvia. Merck and Novartis both struggle with their return on equities, where as Pfizer is in a much position considering this metric.

My pick and final thoughts:

While Pfizer and Merck struggle with the patent expiry drugs, Novartis, continues to enhance the drugs in its pipeline, which gives it an added advantage over the others. Novartis has great prospects in major markets; where it has been able to surge its operations, which indeed are very promising. To top that, the company is also growing very rapidly in Chinese markets, which puts it in a better position to provide reasonable returns to its investors as compared to its rivals. Pharmaceutical division which contributes the most towards Merck’s total sales leaves the company vulnerable to take a nose dive in terms of profits, considering stiff competition offered from generic drug businesses, after the expiry of majority of its patents.

Pfizer and Merck on the other hand are aggressively pursuing share buybacks to bloat per share earnings to appease the investors, which in the longer term is not very sustainable. Moreover Pfizer is experiencing sluggish growth in its top new pills, which paints a disappointing picture for the company profits. Analyzing the drug pipelines for these giant businesses, we come to notice, that Novartis promises to treat a wide array of cancers with the help of its upcoming CART-19, which seems to be a mega blockbuster. In the light of the above mentioned, Novartis is my confident pick of the day. 

Zain Raza has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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