Pfizer: A Defensive Play?

The stock market\'s sharp advance on March 6 gave shaken investors some respite from the daily pounding they\'d taken over the past week. But the rally doesn\'t mean that the mini-correction is over. If you\'re worried that there is still more pain to come, it may be time to play defense. In that vein, it\'s worth paying attention to George Putnam, editor of The Turnaround Letter. The newsletter, which specializes in undervalued, out-of-favor securities, has served its subscribers well. Over the past 15 years through January 31, according to the Hulbert Financial Digest, its picks returned 17% annualized, making it the second-best performer among the letters tracked by Hulbert.

Lately, Putnam has been enamored with stocks that have lagged during the bull market. These stocks, he wrote in his March letter, "might perform relatively well if the market were to head down for a while.\"

Putnam screened for companies in Standard & Poor\'s 500-stock index that have actually declined since the horrific bear market ended in October 2002. He whittled that list down to stocks with dividend yields of 2% or more, based on the idea that healthy yields provide some downside protection during a market plunge.

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Several drug companies, which have been out of favor for years, appeared on the list. Putnam spotlighted Pfizer (symbol PFE). The pharmaceutical giant, with $48 billion in annual revenues, has been plagued by many of the same maladies that have been afflicting the rest of its brethren, including competition from generics and a pipeline of new products devoid of any obvious blockbusters.

As Pfizer built its pharmaceutical empire during the 1990s, its stock grew steadily until shares peaked at $50 in 1999. The stock held up well during the during the 2000-02 bear market, losing just 12%, versus the SP's 47% plunge. But since the market's lowest point (October 10, 2002), Pfizer's stock has sunk an additional 7%.

Today, says Putnam, Pfizer is a bargain. The stock, which closed at $25.19 on March 6, up 2%, trades at just 11 times analysts' 2007 earnings estimates of $2.21 per share, according to Thomson First Call. Putnam recommends buying Pfizer up to $33. "The large pharmaceutical companies will eventually come back into investors' good graces, and when that happens, Pfizer's stock will trade at a much greater P/E multiple," wrote Putnam.

Eventually is the key. Barry Ogden, manager of the Ivy Capital Appreciation fund (WMEAX), says there are no near-term catalysts to spark Pfizer's shares. "This company was the best large-cap drug company of the '90s, but right now, its products are maturing and facing a lot of pressure from generics," says Ogden, whose fund owns a small stake in the company. "The biggest things on Pfizer's side right now are that it's really cheap, and it\'s got a 4.7% dividend yield."

Pfizer produces some of the world's best-selling drugs. But some of its top products, including Zoloft, have already lost patent protection and are facing competition from generic brands. Even worse, drugs accounting for more than half of Pfizer's revenues will lose their patent protection in the next five years. The company also suffered a significant setback in December, when it halted the development of Torcetrapib, a product that was supposed to succeed its cholesterol drug Lipitor.

One piece of good news, Putnam writes, is that Pfizer spends a whopping $7 billion a year on research and development. "Pfizer's scientists have come up with many successful drugs in the past, and there is no reason they won't continue to do so," he writes. At the end of January, Pfizer's new CEO, Jeffrey Kindler, announced that the company is aggressively cutting costs and stepping up its RD to deliver more products more quickly.

On the surface, Pfizer is hardly a financial juggernaut. Pharmaceutical sales rose just 2%, to $45.1 billion, in 2006, and adjusted earnings rose by only 6%. The company expects revenue to remain fairly flat until 2009 or 2010, and sees earnings growing 6% in 2007 and 9% in 2008.

But Pfizer is generating tons of cash. In 2006, it produced $16 billion in free cash flow-earnings plus depreciation and other non-cash charges, minus the capital expenditures needed to maintain the business -- and Pfizer could generate another $13 billion in 2007. That cash provides opportunities for Pfizer to make acquisitions, boost its dividend, and buy back stock. "If Pfizer can come up with a couple of successful new drugs along the way, investors will once again be falling all over themselves to buy the stock," Putnam writes.