Pfizer Inc. (PFE), Merck & Co., Inc. (MRK): Buying the Pharma Dips

After the pullback, Pfizer trades at 12.3 times forward earnings and Merck & Co., Inc. (NYSE:MRK) at 12 times, which is pretty cheap compared to Bristol-Myers Squibb Co. (NYSE:BMY)  at 18.5 times.

Pfizer Inc. (NYSE:PFE) was down nearly 6% after lowering EPS guidance. It posted Q1 EPS of $0.54, below consensus of $0.56. The drug maker also cut full year 2013 EPS estimates from $2.20 – $2.30 to $2.14 – $2.24. Its revenue from established products was also down 16% last quarter on a year over year basis due to several generic versions of Lipitor. Specifically, Pfizer saw Lipitor revenue fall 55% year over year last quarter.

Pfizer Inc. (NYSE:PFE) should see issues related to top line growth going forward due to the upcoming loss of patent exclusivity on Lipitor, Norvasc, Protonix, Camptosar, and Zoloft, as well as other upcoming expirations. Another key drug, Chantix, was severely affected by safety-related issues. Chantix, an oral nicotinic partial agonist for smoking cessation, had initially delivered solid sales. Yet, U.S. sales have been hit ever since Pfizer updated the product label in 2008 to include a potential relationship between Chantix use and neuropsychiatric symptoms. Chantix worldwide sales declined 7% in 2012.

Pfizer Inc. (NYSE:PFE) has a number of notable patent expirations coming up. The company’s major expirations are outlined below.

The upcoming inflow of generic competition will put downward pressure on the company’s revenue and pricing.

Bristol-Myers reported Q1 EPS dropping 36% year over year to $0.41, $0.02 below forecast. Apart from announcing financial results, Bristol-Myers reaffirmed its adjusted earnings guidance for 2013 provided in January. The company still expects adjusted 2013 earnings in the range of $1.78 to $1.88 per share. Recent numbers were impacted by last year’s Plavix patent expiration.

The genericization of Plavix and Avapro in early 2012 has resulted in significant loss of revenue. What’s more concerning is that Bristol’s replacement pipeline for new drugs is lacking. Back in August, Bristol voluntarily suspended a phase II study evaluating hepatitis-C candidate, BMS-986094, following heart failure of a patient in the trial.

Merck & Co., Inc. (NYSE:MRK) has been down over 4% after its recent earnings announcement. Q1 EPS was $0.85 per share, above consensus of $0.78. Meanwhile, revenue for the quarter fell 9% year over year and earnings fell 7% due to genericization of Singulair and a few other products. However, I think Merck could be one of the top picks in the industry.

In conjunction with earnings, Merck & Co., Inc. (NYSE:MRK) lowered its 2013 outlook, due to pressure on sales. The drug company now expects earnings in the range of $3.45 and $3.55 per share, down from its earlier guidance of $3.60 to $3.70 per share. Although the EPS outlook was lowered, the company also announced a new share buyback program under which it will use up to $15 billion to buy back shares, with half to used up over the next twelve months.

Merck & Co., Inc. (NYSE:MRK), like its major peers, will be facing patent cliffs. Yet, Schering has relatively little exposure to patent expirations through 2013. With the Schering merger, Merck should be able to hedge key impending patent cliffs and pipeline failures. The two companies also have minimal product overlap. What’s more is that Merck achieved its merger synergy target of $3.5 billion in 2012.

Merck & Co., Inc. (NYSE:MRK) also has a global restructuring program with plans to reduce the number of manufacturing sites, including animal health sites. The company expects to achieve annual savings of $3.5 billion to $4 billion by the end of 2013 and annual savings of about $4 billion to $4.6 billion once the restructuring program is completed.

Another big initiative is the drug maker’s focus on emerging markets. Emerging market sales accounted for 20% of total pharma sales in the fourth quarter of 2012, with China being a key contributor. Merck is collaborating with Sinopharm for the establishment of a joint venture that will commercialize pediatric and adult vaccines in China. Merck already has a JV with Simcere Pharma to ensure greater reach in the cardiovascular market in China.

Pfizer Inc. (NYSE:PFE) had some robust hedge fund interest going into 2013, with 77 hedge funds long the stock. This includes its top hedge fund owner (by market value) billionaire Ken Fisher of Fisher Asset Management with a $797 million position, making up 2.2% of its 13F portfolio (check out Fisher’s cheap stocks).

Meanwhile, Merck is one of billionaire Stanley Druckenmiller’s favorite dividend picks. At the end of 2012, Druckenmiller owned some 2.4 million shares, which was a 22% increase from the shares his fund owned in the prior quarter (check out the rest of Druckenmiller’s dividends).

As for Bristol, Billionaire Jim Simons is the drug maker’s top hedge fund owner by shares, with over 13 million shares owned going into 2013. Bristol is Simons’ top stock holding in his 13F portfolio, while other drug maker Eli Lilly is third (check out all of Simons’ stocks).

Although both Pfizer Inc. (NYSE:PFE) and Merck appear to be cheap, I think Merck & Co., Inc. (NYSE:MRK) is the better long-term investment, with a solid 11% return on equity, and the best dividend yield at 3.7%, compared to Pfizer’s 3.2% and Bristol’s 3.5%. Merck has made positive strides when it comes to restricting and should continue to perform well on the back of a focus toward emerging markets.