Dark Patent Issues Behind Pfizer's Cash Machine

Pfizer (PFE) reported a 7% decline of $995 million in second-quarter sales to $13 billion, resulting from the unfavorable impact of foreign exchange ($392 million) and further loss of marketing exclusivity for its cholesterol drug Lipitor (in the EU last year). Though management reaffirmed 2013 financial guidance, recent patent loss setbacks for other blockbuster drugs, like its erectile dysfunction drug Viagra, could adversely impact second-half performance results.

PFE Revenue Quarterly Chart

PFE Revenue Quarterly data by YCharts

Once the top-selling pharmaceutical, Lipitor brought in world-wide sales of $10.7 billion in 2010. After the introduction of generic competition in the U.S. in November 2011, branded sales plummeted 81% in FY 2012 to $932 million! The subsequent loss of marketing exclusivity in most major markets in mid-2012, including Europe and Japan, led to a further decline in product sales: Global revenue of the lipid-lowering drug declined 55% year-on-year to $545 million in the second-quarter 2013.

Encouraged by easing patent cliff headwinds and the opinion that top-line growth from five new products launched in the last 12 months will offset sales of other branded drug sales lost to generics– including the psychotropic Effexor, glaucoma drug Xalantan, and antacid Protonix – management is forecasting (adjusted) earnings of $2.10 to $2.20 per share on revenue of $50.8 billion to $52.8 billion for 2013. This compares with (adjusted) share-net of $2.19 on revenue of $54.6 billion last year. Adjusted earnings reflect the 2012 disposal of its Animal Health business Zoetis (ZTS).

Through successful litigation, Pfizer has extended the patent for its sex drug Viagra (sildenafil) in the U.S. until October 2019. However, up to twenty generic manufacturers, including powerhouse Teva (TVA), are poised to market their own versions of the little blue pill in Europe and other global markets after international patents expired in June. Worldwide sales totaled $945 million in 1H:2013 (4% of product sales), with half of this revenue coming from abroad.

Concerns have been expressed, too, by analysts that the drug could lose incremental sales here at home to a generic version of Pfizer’s proprietary treatment for pulmonary arterial hypertension, Revatio, which contains sildenafil as the active ingredient and lost marketing exclusivity in November 2012.

Albeit Pfizer is looking to mitigate the impact of generic competition by bringing to market new products, including treatments for auto-immune disorders, cardiology, and oncology, as demonstrated by Viagra, its portfolio of drugs at-risk of losing market exclusivity is high. Up to 35% of the $23.6 billion in sales derived from branded pharmaceuticals in 1H:13 is either currently battling an onslaught of cheaper alternatives or will soon face generic competition, including several best-selling drugs:

• Amgen’s (AMGN) big win in securing patent extension of the immune-mediating biologic blockbuster Enbrel (etanercept) out to 2028 in U.S. courts means little for Pfizer, which only has marketing rights abroad. With Enbrel copies already on the market in Asia and India, and the Novartis AG (NVS) subsidiary Sandoz readying a biosimilar version for rheumatoid arthritis and psoriasis, Pfizer’s $3.7 billion franchise could be in serious jeopardy.

• The original basic patent for Celebrex, known chemically as celecoxib, expires on May 30, 2014, which means cheaper substitutes to the $2.7 billion pain med could be on U.S. pharmacy shelves no later than January 2015.

• Pfizer had success in transitioning patients suffering from an overactive bladder from Detrol (tolterodine) to the long-acting version (LA). As a result of litigation settlements, however, investors can expect generic substitutes from Impax Labs (IPXL) and Mylan (MYL) to commence sales in the U.S. next year, according to regulatory filings. The Detrol franchise generated $761 million in sales last year.

• Marketing exclusivity for Zyvox (linezolid), used to treat bacterial infections ($1.3 billion in 2012 sales) and the antidepressant Pristiq (desvenlafaxine), a $630 million successor agent to the off-patent psychotropic Effexor (venlafaxine), are being challenged by generic manufacturers, too.

Despite operational pressures from expiring patents, credit rating agency Fitch believes the company’s financial metrics remain healthy: Total debt leverage will remain steady due to further decreases in Pfizer’s overall debt level from payment of $6.9 billion in maturing securities through 2015. Most of the $31 billion in long term debt doesn’t come due before 2017.

PFE Financial Leverage Chart

PFE Financial Leverage data by YCharts

Fitch believes, too, that Pfizer will continue to throw-off generous liquidity: Cash equivalents totaling some $35 billion (cash and short term investments) plus unused lines of credit equaling about $7 billion (expiring in 2016). The credit agency opines continued success in extracting cost reductions from operations combined with top-line growth from new products should generate free cash flow (operating cash less dividends and capital spending) greater than $8.6 billion annually over the next few years.

One can do one's own investment research. Year-to-date, Pfizer has bought back $8.7 billion in common stock – a buyback yield of 4.8% -- up from $8.3 billion in common equity in all of 2012. Nonetheless, unless the company can successfully offset sales lost to generic competition with new product launches, it will take more than aggressive stock repurchases to keep shareholders happy.

PFE Net Buyback Yield TTM Chart

PFE Net Buyback Yield TTM data by YCharts

David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive. He can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.



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