Pharmas of the Dow.
The three pharmas in the DJIA are Merck (MRK), Pfizer (PFE) and Johnson & Johnson (JNJ). The three have much in common. For starters, they are the “evil” drug companies that politicians love to talk about (while pandering to their constituents); and the target of trial lawyers who try to bilk them for “easy money”. Merck’s response to the Vioxx lawsuits was fantastic…. They emphasized the fact that “there is/will be NO easy money to be made on Vioxx, and we (Merck) will fight every lawsuit”. Needless to say, PPC rates at Google dropped from $20 per click for Vioxx to less than 50c in a week! Merck recently backed off this stance and has agreed to negotiate a settlement.
Getting back to the issue at hand – MRK, PFE and JNJ. JNJ derives 40% of its sales and 48% of its bottom-line from Pharma. 36% from devices and diagnostics, and 24% of revenues (16% of profits) from consumer. Their international business was 47% of sales. PFE derives 52% of its sales through its international division, and Merck, 37%. All three are down-sizing their work-force to reduce costs, and Pfizer in particular is still digesting its two huge purchases of Warner Lambert and Pharmacia.
Notable facts/numbers:
1. MRK and JNJ easily earn and pay for their dividend. PFE too easily earns their dividend, but has had to borrow money in the US – while being unwilling to repatriate money to the US from its international operations as they (Pfizer) are likely to lose as much as 20c per dollar on the repatriated dollars.
2. All three suffer a weak pipeline of drugs and while JNJ and PFE have historically been more aggressive and have acquired large companies, Merck is a lot more conservative [but for their 1993 buy-out and 2003 spin-off of Medco, the world's largest PBM].
3. JNJ and MRK have operating margins of about 33% and net margins of over 20%. PFE has operating margins of 47%, and net margins in excess of 30%.
4. JNJ sports the highest growth rate (high single digits), highest PE (low teens) and lowest yield (2.5%) among the three, and has the distinction of being part of Berkshire Hathaway’s portfolio. Merck is somewhere in the middle as they have addressed most of their liability issues with Vioxx. PFE sports the lowest PE and highest yield – due to the fact that they still sell Celebrex [albeit in a black box], and sold Bextra till 2005. In other words, PFE has a huge unaddressed potential liability, or they are the smarter than Merck [if they do not have to pay out anything for their two COX-2 inhibitors].
5. JNJ has a consumer division, but it contributes to only 16% of profits [brands include Aveeno and Neutrogena]. Pfizer recently divested their consumer division, and Merck’s consumer/OTC division is a j.v. with JNJ.
6. MRK spends 20% of their revenues on R&D. PFE spends about 17%, and JNJ, 13%.
7. JNJ is owed money by Boston Scientific [and possibly by others] in the stent wars. PFE and MRK will eventually buckle down and pay up a lot of money for manufacturing COX-2 inhibitors [NSAIDS].
Conclusions:
1. JNJ is the best stock of the bunch – with the highest sustainable growth rate and a modest yield, plus the company aggressively buys back its shares.
2. MRK is my #2 pick – with a lower growth rate, and having addressed most if not all of their liabilities. Plus the company has in the last decade, retired almost 10% of its shares.
3. PFE is my #3 pick. While the yield is easily earned, they are in a tight spot when it comes to repatriating $$$ from their foreign operations to pay the dividend [and they have temporarily stopped stock repurchases due to this fact].
Disclosures: Long all three stocks.