Pfizer's the Way to Go in the Drug Sector

What's the best drug stock to own? Some value investors think it's Merck (MRK), while well-known contrarians including Scudder's David Dreman favor Bristol-Myers (BMY).

But I would argue they're both wrong. Because pound for pound, I think the answer is Pfizer (PFE).

Just take a look at its drug portfolio and pipeline and you'll see what I mean. It sports four multibillion-dollar products that have the potential to post double-digit growth over the next year: Lipitor (for cholesterol), Norvasc (hypertension), Zoloft (depression) and Neurontin (epilepsy). In addition, it has several early stage drugs including Rebif (multiple sclerosis) and lasofoxifene (osteoporosis) that some folks -- including Salomon Smith Barney analyst George Grofik -- think could tag on another half a billion in sales each over the next few years.

What does Merck have? To its credit, it has two new promising drugs in the works, Ivanz (an antibiotic) and Zetia (for cholesterol), that could add $600 million in sales next year. But beyond that, a number of its core products including Zocor (cholesterol) and Vioxx (arthritis) are nearing maturity.

Bristol-Myers is in a similar position. It has a couple big winners in the hopper including Pravachol (cholesterol) and Plavix (stroke). But several of its smaller growth engines, including Zerit (HIV) and Monopril (blood pressure), have begun to peter out.

Then there's cash flow. Over the past three years, Pfizer's operational cash flow has grown by more than 69%, while Bristol and Merck have seen theirs rise just 27.8% and 48.1%, respectively.

The naysayers argue that Pfizer at 20 times forward earnings is just too expensive. But is it really? Pfizer has more leverage over its cost structure than its competitors. The fact is, over the trailing 12 months it's managed to garner an operating margin of 32.9%, which is substantially better than either Merck (20.8%) or Bristol (10.7%). Put another way, Pfizer has much more room for error, and in this market, I like that.

Lastly, consider its pending acquisition of Pharmacia (PHA). As things stand now, Pfizer's management is guiding that it will be able to deliver $1.4 billion in synergies in 2003, and that annual cost savings could top $2.5 billion by 2006. But I'll wager that those numbers are conservative. Here's why:

First, there is very little product overlap. In fact, Pfizer will be gaining a valuable presence in both ophthalmology and oncology. In addition, unlike Merck, Pharmacia has no major patent expiration issues till 2007, meaning that Pfizer will have plenty of time to use its marketing muscle to build out Pharmacia's pipeline.

Second, Pharmacia's operating margin has hovered around 19% over the last year on low single digit revenue growth. But as some of its new drugs, including Bextra (for arthritis), hit their stride, its sales growth should accelerate to the mid to high single digits by next year. And as this happens, it should be able to expand its margins materially.

Bottom line: In terms of price-to-earnings, Pfizer looks expensive. But its fundamentals and prospects for future growth make it worth every penny.

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