Valuation Report

Equity Valuation Report for Finance 321

Pfizer, Inc. (PFE)

Recommendation: BUY Price Target: $30.00

May 27, 2010

Ticker: PFE Price: $15.37 E arnings/Share (in dollars, $) Q1 Q2 0.54 2005A 0.59 2006A 0.68 2007A 0.61 2008A 0.54 2009A 0.64 2010 PFE Highlights & Events

Q3 0.45 0.5 0.42 0.55 0.48 0.49 0.54 0.58 0.62 0.52

Q4 0.49 0.43 0.5 0.65 0.49

Y a 1.97 2.06 2.18 2.43 2.03 0.64

Pfizer Reports First-Quarter 2010 Results; Reaffirms 2010 Financial Guidance (May 2010 : Pfizer has announced a 48% increase in first quarter revenues after the Wyeth integration. Net income has decreased by 26%, stemming from high interest expenses due to the acquiring of Wyeth in 2009. Furthermore, the effective tax rate increased from 28% to 36% from 2009-2010. However, plans to aggressively decrease overall costs by 2012 and enter markets with successful clinical trials provide a positive outlook. Mergers/Acquisitions (October 2009 : The Pfizer-Wyeth merger was completed in October 2009. Through 2010, Pfizer has fully integrated Wyeth within their organization

Ma k t
52 Week rice Range Average Daily Volume Beta Dividend Yield Shares Outstanding M arket Capitalization Institutional Holdings Insider Holdings Book Value per Share Debt to Total Capital Return on Equity (ttm)

o l
13.94 - 20.36 71,483,000 0.67 0.72 (4.80%) 8.06B $125.11B 71.30% 0.05% 1.38 0.57 10.54%

World Bank and Pfizer Announce Initiative to Help Improve Healthcare Delivery in Developing Countries (April 2010 : Pfizer is gaining popularity and becoming involved with international aid primarily in Africa to increase the availability of healthcare products. The proposal is being driven by the World Banks new eTransform Initiative that uses technology to ameliorate the overall supply chain and infrastructure of the emerging country.

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y Pfizer Hosts Annual Meeting of Shareholders; Declares 18-Cent SecondQuarter 2010 Dividend (April 2010 : Pfizer announced the 286th consecutive quarterly dividend to be paid on June 1, 2010. Despite tumultuous economic conditions, they have still managed to pay out a dividend for 2010, and have increased $.02 since the last 3 quarterly payouts. Pfizer has also established policies that allow shareholders to vote for executive compensation practices, a recent development prompted by public scrutiny regarding executive pay. Increased Transparency (March 2010 : Pfizer Invites Public to View and Listen to Webcast of May 4 Conference Call with Analysts; Pfizer Posts Details About Interactions With U S Physicians Other Healthcare Professionals And Clinical Research Partners: Pfizer established the first corporate governance department in the US (1992). The company has made major efforts to increase public transparency by allowing its stakeholders and general public to access details on relations with physicians with physicians and clinical research organizations (CROs), in addition to costs associated with consulting and clinical trials. The public know remains more confident through transparency measures taken by Pfizer. This corporation has been the first within the pharmaceutical industry to address these issues.

Investment Summary
Pfizer Inc. is an industry leader and the largest research-based pharmaceutical organization. With recent acquisitions to diversify the organization and aggressive financial plans, it is an attractive investment with a positive future outlook. Primary Reasons to Invest: y Reputation: Pfizer earned a distinguished position within the Fortune 500 rankings as number 48. The popularity in the prescription drugs sector has placed the company at the forefront of the highly concentrated pharmaceutical industry, where 50 of the largest firms make up 80% of all revenue. y Diversification: With the recent acquisition of Wyeth, Pfizer has not only eliminated a competitor, but has also moved into the consumer products sector. It has diversified its product lines amongst vaccines, antibiotics, women's health, inflammatory and cardiovascular conditions, and gastroenterology. y Research and Development Achievements & Partnerships: Being one of the largest research-based pharmaceutical organizations, Pfizer has strategically begun to work with other industry peers such as Bristol-Meyers Squibb and GlaxoSmithKline, which has led to developmental breakthroughs. Recently, the organization also granted permission to scientists at the University of Washington to focus on discovering new uses for existing compounds. These efforts will assist in realizing new patents that will further assist with the growth of the organization. y Financial Plans: Since the acquisition of Wyeth, Pfizer has been aggressively cutting costs by eliminating production facilities and plans to shrink the overall workforce by15%. This yields less overall costs and a stronger financial position, the organization plans to decrease expenses significantly by 2012. y Transparency: As reported via press releases and public events, Pfizer has increased its transparency with the public and its stakeholders by allowing access to information on clinical trials. Pfizer has already implemented voting rights on executive compensation while competitors in the industry are yet to do so. y International Presence & Emerging Markets: Roughly 66% of Pfizers total revenue is generated from international locations. With significant revenues generated via international markets, Pfizer can benefit by exercising more opportunities abroad. By doing so it would be able to capture a greater market share for its revenue streams. Furthermore, with the acquisition of Wyeth, and many other small organizations, Pfizer has taken steps to become an industry

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leader with immense international exposure. Presently due to the acquisition of Wyeth, Pfizer has gained a competitive advantage. Prior to the acquisition, Wyeth already had significant global exposure in the pharmaceutical industry.

Figure 1: Industry Stock Performance Comparison

Blue: Pfizer; Green: Merck; Red: Johnson & Johnson; Inc, Purple: Bristol-Meyers Squibb; Yellow: Eli Lilly
Source: Yahoo Finance

Valuation
The discounted cash flow valuation method was utilized to determine the intrinsic value of various stocks within the pharmaceutical industry. There were many steps to determining important variables to input the relevant data in the live excel document supplied. Beta A pivotal attribute of the discounted cash flow analysis is beta. Beta measures the systematic risk of a stock over a set period of time. In our analysis, we used the historical stock prices for the past three years, and generated returns for each of the industry stocks. Next, we used the same method to calculate the market returns. By using the aforementioned data, we were able to determine the beta, using the covariance of each stock to the market (Wilshire 5000), divided by the variance of the overall market. Furthermore, adjustments were made to account for the small sample size. As shown in the excerpt below, the calculated betas were close to those as shown by key statistics supplied by various resources.
Figure 2: Calculated betas for competitor stocks: Extracted from spreadsheet containing essential data.

Pfizer Calculated Yahoo 0.5538 0.67

Merck 0.75075 0.78

Eli Lilly 0.75434 0.8

Discounted Cash Flow Analysis Our analysis was based upon a pre-calculated model that encompasses various attributes such as cash flow per share, capital spending per share, common shares outstanding, working capital, and long term debt. In addition, forecasted figures, supplied by valueline (valueline.com) were used populate the model that simultaneously generated changes in working capital and long term debt.

Figure 3: Free Cash Flow to Equity: Extracted from spreadsheet containing essential data.

Computing FCFE - baseline case Cash flow per share Capital Spending per share Common shares outstanding [million] Working Capital [$ million] Change in working capital per share Long-term debt [$ million] Change in LT debt per share FCFE

2008 1.94 0.25 6746 16067 7963

2009 1.66 0.15 8070 24445 0.65 43193 4.17 5.03

2010 1.7 0.2 8070 28000 0.44 45000 0.22 1.28

2011 1.85 0.2 8070 25000 -0.37 48000 0.37 2.39

2012 2.2 0.2333 8070 23333 -0.21 51000 0.37 2.54

2013 2.55 0.2667 8070 21667 -0.21 54000 0.37 2.86

2014 2.9 0.3 8070 20000 -0.21 57000 0.37 3.18

With this information, and given factors such as market risk premiums and risk free rates, the required rate of return was calculated (k). By utilizing previously determined betas, the present value of future cash flows and the intrinsic value estimate were computed.
Figure 4: Intrinsic Value Calculation: Extracted from spreadsheet containing essential data.

2010 Beta(DD) Risk-free rate Market risk premium k Perpetual growth rate after first stage PV(FCFE) Terminal Value TV PV(TV) Intrinsic value estimate 0.67 4% 6% 8.00% 2.50% 1.19 59.02 40.13 49.65

2011

2012

2013

2014

2.05

2.02

2.1

2.16

As depicted by our model, the intrinsic value estimate is $49.65, while the actual price of the stock is a mere $15.23. According to this, Pfizer is clearly undervalued. Interestingly, a smaller margin of underestimation was observed in competitor stocks, based upon closer estimates. After initial analysis, we proceeded to understand the validity of the forecasted valueline information. Essentially capital spending in terms of cash flow per share, and sales per share, for the past ten years was computed. These figures were compared to forecasted values observed for 2014. Similar analysis was done to analyze working capital and long term debt. Most of the resulting forecasts were fairly reasonable, except when evaluating a competitor stock in terms of working capital. However, this was expected based on the observation that the increase of forecasted working capital was larger than previous years. An adjustment typically executed to the changes in long term debt is to bring the comparables to a common ground. Through extensive evaluation of Pfizer and select comparables, a large spread between the comparables was observed in terms of debt to equity. This can be attributed to the recent acquisition of Wyeth Pharmaceuticals by

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Pfizer, stemming from the inheritance of an inordinate amount of long term debt. Despite Merck encountering similar consequences due to the acquisition of Schering Plough in 2009, the company had more than a year to fully integrate the organization and implement structural changes. Major differences observed between Pfizer and its comparables are temporary given the current atmosphere of the industry. However, the acquisitions/merger climate within the pharmaceutical industry makes it difficult to bring even the strongest competitors to common ground. As per the methods of valuation, adjustments were made for the differences in long term debt by amending the change in debt 2014 to 0%, as it is not realistic to forecast continuous decreases to long term debt, because eventually they are paid off completely. Although an effect was observed with Pfizer, the stock still remained undervalued. Opposite effects were observed with competitors Merck and Eli Lilly; both of these stocks increased in value. Causes of Underestimation: Theories Presented As per extensive analysis of Pfizer, a determination was made that Pfizer stock is undervalued. As observed through evaluation, this is directly attributed to the present values of forecasted Free Cash Flow to Equity that are added to determine the intrinsic value estimates. However, it seems as though these cash flows are not accounted for in the current prices. FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt- Debt Repayment Free Cash Flow to Equity is a measure of how much cash can be paid to the equity shareholders after all expenses, reinvestment, and debt repayment has been paid out. Pfizers FCFE values are high estimates, especially compared to its competitors, which are due to the following reasons: y Cash flow per share: Pfizer has lower operating cash flows, which could be traced to the increased costs since their recent acquisitions. However, as previously described, there are aggressive plans to cut costs by 2012 (primarily work force costs), which should increase cash flows. Pfizer also has more outstanding shares than its industry peers. This has a minimizing effect on cash flow per share. Forecasted decreases in net working capital: Pfizer is forecasted to decrease their net working capital for future years, especially in comparison to industry peers. This has an effect on the companys intrinsic value; as such decreases increase their FCFE. Small increasing capital spending per share: As previously suggested, Pfizers capital spending per share also increases at a smaller rate than industry peers, which maximizes changes in net working capital (due to the subtraction of less value). In depth analysis has been utilized to determine that this may be partly due to the acquisition of Wyeth, where an acquirement of capital may yield a decrease in spending.

These factors suggest higher FCFE, and after determining their present value, and adding to the terminal value in the model, an intrinsic value is determined. Price Target Determination Another essential step in the valuation process is setting a valid price target for the stock being evaluated. After extensive research into multiple approaches, a determination was made regarding an effective price target using the fundamentals and

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actual data instead of figures contingent merely on optimism and press releases. A viable approach to this problem was to use both the current and forecasted P/E ratio in addition to the current price. Various predictions and more recent information available led to the usage of the most current data and assumptions.
Figure 5: Price Target Valuation: Extracted from spreadsheet containing essential data (finance.yahoo.com).

PFE P/E Forward P/E

13.94 6

Price x ((current P/E) / (forward P/E)) = future price (or price target) $34.83 Based on initial optimistic figures, additional research on available Pfizer valuations was conducted. According to the research and calculations, the calculated price target was on the estimated high end. Various analysts also recommended purchasing the stock and provided similar figures for the price target. Although a price target valuation of $34.83 was observed, rounding slightly lower to $30.00, below the target valuation, is feasible and in line with studied analyses. Furthermore, through conducted research on Pfizers increasing size, and diversification into new markets, the price target can be met by 2012. This is attainable assuming that plans regarding aggressive changes in financials and projections are taken.

Business Description
Pfizer, the largest research-based drug maker in the world, operates three core business segments: healthcare, animal health and consumer healthcare. Its global business has a market presence in 150 countries, with its most popular and marketed drugs being Viagra, Zoloft, and Lipitor. Its consumer healthcare segment, while not the most lucrative division, still boasts successful products such as Listerine, Rolaids, Visine, and Sudafed. The company deals directly with healthcare providers and patients to sell its products. As mentioned previously, Wyeth was acquired by Pfizer which further increased the companys market share and research efforts.

Industry Overview and Competitive Positioning

Industry overview Pfizer belongs to the highly profitable pharmaceuticals manufacturing industry. The US pharmaceuticals industry generates annual revenues of approximately $200 billion and includes 1,500 companies. Relevant industry competitors incorporated into our valuation of Pfizer Inc. include Eli Lilly, and Merck. Unlike other industries, this industry remains highly concentrated, with the top fifty revenue makers generating an overwhelming 80% of revenue. Key Competitors y Merck & Co. Inc (MRK): Pfizers major competitor, is a global health care company focused on the discovery, development, and manufacturing of medicine, vaccines, biologic therapies, and consumer and animal products. Its pharmaceutical segment provides human health products such as therapeutic and preventive agents. y Eli Lilly & Company (LLY): manufactures, develops, and sells pharmaceutical products worldwide. It distributes its products through independent wholesale distributes and directly to pharmacies. The company was founded in 1876 and is based in Indiana.

Conclusion
Through extensive research and an overall stock evaluation on Pfizer, we feel that this is a premier stock that should be purchased by investors looking to invest within the pharmaceutical industry. With growth potential through diversification and increased revenue streams through acquisitions and partnerships, this organization is in a position to expand greatly in the next few years.

Appendix & Resources

For further information on stock valuation, please reference excel document containing valuation analyses in conjunction with this report. Resources  "Hoovers | Business solutions from Hoovers." Hoovers | Business solutions from Hoovers. N.p., n.d. Web. 1 June 2010. <http://www.hoovers.com>.  "Pfizer.com | Pfizer: the world's largest research-based pharmaceutical company." Pfizer.com | Pfizer: the world's largest research-based pharmaceutical company. N.p., n.d. Web. 1 June 2010. <http://www.pfizer.com>.  "Value Line - The Most Trusted Name in Investment Research." Value Line The Most Trusted Name in Investment Research. N.p., n.d. Web. 1 June 2010. <http://valueline.com>.  "Yahoo! Finance - Business Finance, Stock Market, Quotes, News." Yahoo! Finance - Business Finance, Stock Market, Quotes, News. N.p., n.d. Web. 1 June 2010. <http://finance.yahoo.com>.