Pfizer Stock: Graham P/E Shows Large Discounts

Summary:

• I view Pfizer Inc. as a leader in a defensive sector under temporary ROCE pressure.
• Its profit recovery and growth prospects are substantially underestimated by the prevailing market consensus.
• Even assuming the market’s pessimistic consensus outlook, it is discounted by more than 10% from the Graham P/E.

PFE stock: Buy rating reiterated

Back in May 2024, I wrote an article titled “Pfizer Stock: Rebound Has Started (Technical Analysis)” about Pfizer stock (NYSE:PFE, NEOE:PFE:CA). As the title already suggests, the article placed an emphasis on its recent technical trading patterns. Quote:

Pfizer’s earnings and sales have fallen due to decreased demand for COVID-19-related products, leading to a large selling pressure this year. The stock price has recently started rebounding from its low point and is showing bullish technical signs for continued momentum. These signs included a crossover of its 20-day moving average, strengthening Relative Strength Index (“RSI”), and also trading volume patterns. Besides these technical signs, I also see some fundamental catalysts that could support further price rallies.

To complement this previous article, I thought it would be helpful to write this follow-up article to concentrate on the fundamental side of the stock. In particular, given PFE’s prominent position in a stable sector, I think it is very fitting to apply the framework that Benjamin Graham developed for the analysis of defensive stocks. The rest of this article will explain how this framework points to a buy rating. Notably, even assuming the market’s pessimistic growth outlook, PFE is currently discounted by more than 10% from the Graham P/E, a growth-adjusted valuation metric to be detailed next.

PEF stock: headwinds and EPS growth outlook

Undeniably, PFE faces some profit headwinds ahead. On the top of my list is the drag from its COVID-related products. I expect the drag to continue in the upcoming quarters, assuming the cases keep fading away. To wit, Pfizer’s vaccine franchise (Comirnaty) and its therapeutic (Paxlovid) generated combined sales of about $57 billion in 2022. This figure plummeted to $12.5 billion in 2023. I expected this number to keep falling in FY 2024. These headwinds are reflected in the following consensus EPS estimates for PFE stock. According to the data, you can see that analysts expect PFE’s EPS to grow at a compound annual growth rate (CAGR) of only 1.9% for the next 5 years from 2024 to 2026.

I certainly acknowledge the headwinds, but I think the above consensus is too pessimistic. As a back-of-envelope estimate, I expect its growth to be around 4% in the midterm to long-term (say 5 years or more). My estimates follow the approach details in my earlier articles. I will only quote the results here:

The method involves the return on capital employed (“ROCE”) and the reinvestment rate (“RR”). The ROCE for PFE has been around 44.6% on average in recent years as seen in the chart below. Its RR is about 15% on average. As such, I expect its long growth rate to be ~6.9% (44.6% ROCE x 15% RR = 6.9%).

It is current ROCE (as of TTM 2024) is only 27% due to the above headwinds. It reflects temporary setbacks, is far below the average, and should be considered an outlier in my view. However, even assuming a ROCE of 27% going forward, the organic growth rate should still be about 4% (27% ROCE x 15% RR = 4% growth rate).

PFE stock: Graham P/E and Graham Number

Even assuming the above pessimistic growth outlook implied by consensus EPS forecasts, PFE’s valuation is still discounted by a sizable margin from Graham’s metrics. I will rely on two of them in this article, as summarized in the table below. For readers new to these metrics, they are the so-called Graham P/E and Graham number, as defined below:

Graham P/E: Graham recommended the P/E for a defensive stock should be around 8.5 plus twice the expected annual growth rate, which I call the Graham P/E.

Graham Number: In general, Graham cautions against paying a price of more than 15x times earnings or more than 1.5x times the book value (“BV”). However, a P/E multiple above 15x could be justified if the P/BV ratio is lower than 1.5x. And vice versa. And as a result, the Graham number considers both the 15x PE limit and the 1.5x P/BV limit. More specifically, the Graham number is the square root of A) 22.5 (which equals 15 times 1.5), B) the EPS, and C) the book value.

If you recall from an earlier chart, PFE’s FWD P/E is about 10.88 only as of this writing. Assuming the 1.9% growth rate projected consensus (again, too conservative in my view), the Graham P/E for PFE turns about to be 12.3 as shown (8.5 + 2 * 1.9). Thus, its current market P/E still represents a discount of about 12%.

Other risks and final thoughts

Another key upside risk is the progress the company is making on the cost control front. Judging by its recent financials, I believe the company is on track to deliver at least $4 billion of net savings from its expense-realignment program by the end of 2024. The improved cost base should position the company well to achieve margin expansion, profitability recovery, and growth in the years to come.

In terms of downside risks, besides the COVID-related headwinds mentioned above, PFE also faces other risks common to drug stocks. These risks include regulatory hurdles, uncertainties with pipeline drug developments, pricing pressures, etc. As a well-covered stock on the Seeking Alpha site, these risks have been thoroughly discussed by other SA authors. Here, I will just mention a risk that is more pertinent to the particular approach used in this article: the uncertainties with Graham’s valuation metrics. If you recall from my table above, PFE’s current market P/E indicates a discount of about 12% from the Graham P/E. However, the discount is much smaller in terms of the Graham number, about 5% only. The Graham number, by factoring in the BV, provides an additional perspective to assess its current valuation.

To conclude, my verdict is that the upside potential exceeds the downside risks under current conditions. Thus, I see a skewed return/risk profile and reiterate my BUY rating on PFE stock. In addition to the arguments made in my previous article (which are primarily technical and near-term oriented), I see it offers a strong combination of healthy fundamentals and attractive valuations in the long term. It is a leader in a defensive sector, under temporary ROCE pressure, with growth prospects substantially underestimated by the prevailing market consensus.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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