The Four Questions that will determine go / no-go on EP separation

Transcription

1 May 5, 2016 Pfizer The Four Questions that will determine go / no-go on EP separation Industry View In-Line Stock Rating Equal-weight Price Target $36.00 Mgmt will decide by YE16 whether to separate Pfizer into Innovative and Established Products (EP). We discuss "The Four Questions" and explain how shifting Viagra & Lyrica from Innovative to EP could impact earnings & growth prospects for each segment. Bumping PT from $35 to $36 on higher EPS. What's Changed? From Pfizer Inc Price Target $35.00 $36.00 We tried to answer "The Four Questions." Pfizer management must answer Yes on four questions before proceeding with a separation of Established Products (EP) from Innovative Products (IP). See "Our answers to "The Four Questions"'," which also discusses the two ways that CEO Ian Read mentioned to assess trapped value, the financial impact of moving US Viagra and US Lyrica from IP to EP, and our view on EP strategic action that could create the highest shareholder value. To MORGAN STANLEY & CO. LLC David Risinger David.Risinger@morganstanley.com Thomas Chiu, M.D. Thomas.Chiu@morganstanley.com Onusa Chantanapongwanij, M.D. Onusa.Chantanapongwanij@morganstanley.com Emil Chen Emil.Chen@morganstanley.com Pfizer Inc ( PFE.N, PFE US ) Major Pharmaceuticals / United States of America Stock Rating Equal-weight Industry View In-Line Price target $36.00 Shr price, close (May 3, 2016) $33.70 Mkt cap, curr (mm) $209, Week Range $ Fiscal Year Ending 12/15 12/16e 12/17e 12/18e ModelWare EPS ($) Prior ModelWare EPS ($) P/E Consensus EPS ($) Div yld (%) Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare framework = Consensus data is provided by Thomson Reuters Estimates e = Morgan Stanley Research estimates "The Four Questions": 1. Are each of the businesses performing well within Pfizer? 2. If separated, would they continue to perform as well? 3. Is there trapped value in the combined entity? 4. Can the trapped value be unlocked efficiently (do the benefits outweigh the costs)? Separately, we updated our model to reflect 1Q:16 results and new guidance. We raised 2016e revenues from $50.4B to $52.9B (guidance $ B) and EPS from $2.27 to $2.46 (guidance $ ). Our 2017e revenues and EPS estimates are $55.8B (previously $52.9B) and $2.67 (previously $2.52). Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. 1

2 Risk Reward Investment Thesis We are Equal-weight Pfizer shares as we envision modest upside potential given single digit growth prospects. There is the potential for greater shareholder return (Bull Case) in the event of financial and strategic upside. Management remains committed to driving shareholder returns via share repurchase, dividend increases, and external deals. Source: Company data, Thomson Reuters, Morgan Stanley Research estimates Price Target $36 Bull $40 14x 2017E EPS of $2.85 (7% above base case) Base $36 13x 2017E EPS of $ x '17e EPS of $2.67, compared to the Major Pharma peer group median 17 P/E of 15x, because we project PFE 3-year ( e) CAGR EPS growth of 10% vs. group median of 14% Oncology franchise and share buybacks drives EPS above forecast; shareholder value is more enhanced via company split than we currently foresee. Cancer drugs plus extra share buybacks drive combined 7% EPS upside. P/E benefits from splitting the company into two (Innovative and Established Products). The stock multiple expands. Pfizer executes well on the base business and pipeline. Core EPS is in line with expectations, and pipeline newsflow is encouraging. Mgmt pursues external transactions to enhance Pfizer's innovative pipeline. Key Value Drivers Financial results relative to expectations Pipeline progress Potential transaction activity Customer developments (both commercial and government payers) Potential Catalysts Financial results Potential company split (board decision by yearend 2016). External M&A Pipeline newsflow US political developments, including implications of November 2016 election result for investor perception about the threat of government pricing pressure. Bear $30 12x 20167E EPS of $2.48 (7% below base case) Financials, pipeline, and/or strategic action disappoints. Revenue shortfalls due to competitive pressures cause EPS to fall 7% below expectations. The P/E contracts due to pipeline disappointments and/or investor frustration with either lack of strategic action or high prices paid for deals. Risks to Achieving Price Target Upside: Core business upside, positive pipeline developments, and/or external transactions which boost shareholder value. Downside: Revenue shortfalls cause EPS misses, P/E contracts due to pipeline disappointments, and/or Pfizer overpays for potential acquisitions. 2

3 Our answers to "The Four Questions" We tried to answer "The Four Questions" Pfizer management has stated on more than one occasion (including on the 1Q:16 earnings call) that executive management must answer Yes on four questions before proceeding with a separation of Established Products (EP) from Innovative Products (IP). 1. Are each of the businesses performing well within Pfizer? In 2015, EBITA for Innovative Products (GIP + VOC) grew 26% and declined 25% for EP (Exhibit 1), but EP experienced major patent expirations including Celebrex, Zyvox, and EU Lyrica. EP EBITA margins were 52% in 2014, 46% in 2015, and 47% in 1Q:16, but it is unclear how margins will trend long-term. Positive drivers include injectable generic and biosimilar launches; negative drivers include sales erosion due to competition (i.e. Pfizer brandedgenerics going "generic-generic" over time). 2. If separated, would they continue to perform as well? It is encouraging that management stated on the 1Q:16 call that dis-synergies would be immaterial relative to earnings, being only "a couple of cents per share on an annualized basis." But management declined to provide growth objectives. While we see compelling growth prospects for the Innovative segment, the growth trajectory of Established Products (EP) is uncertain due to risk of branded-generic market share erosion due to generics, limited EP R&D spending, plus EP dependence on biosimilars, the outlook for which is still evolving. Finally, many healthcare corporate splits have resulted in greater reinvestment requirements and/or higher tax rates than expected for the separated entities. 3. Is there trapped value in the combined entity? In our view, the answer would be highly dependent on the value of PFE shares at the time of the assessment. Furthermore, key variables would include determining the appropriate growth forecasts and valuation comps for EP. On the call Ian Read commented that the franchise has some qualities which are similar to consumer products companies and stated "...the established business is a unique business including strong sterile injectables, strong biosimilar capabilities in big emerging markets, and it's not really generic business. So it's very hard to find a comparison there. I'm sure we'll be able to find some composite." 4. Can the trapped value be unlocked efficiently (do the benefits outweigh the costs)? This question is difficult for outsiders to answer because the costs are uncertain, such as dis-synergies, tax leakage, requirements to share manufacturing/salesforces/brands between the two entities, and need for EP to invest more in R&D to enhance its long-term revenue prospects. Also, we don't know how high a US dividend Pfizer can assign EP because the majority of cash flow is trapped ex-us. Ian Read mentioned two ways to asses trapped value SOTP and historical precedents He stated, "...we'll obviously use outside advisors. But one of the classic methods would simply be to look at sum of the parts as much as we can establish by disaggregating our business the same ways we give you information to do. So we can take those businesses and compare them to standalone businesses and see what a potential evaluation would be with the parts, and compare it to the sum... Another is to look historically at what has happened to companies where they have spun but they have been spun in an unforced manner i.e., because of management's decision and not because of activist pressure and see what has happened to the shares of those companies subsequently. And of course we'll also have to look at what are the tax implications, which really circles back to standalone abilities if companies are disadvantaged in a more specific way because of their tax situation compared to their 3

4 competitors." Pfizer May 5, 2016 Pfizer could move US Viagra and US Lyrica from IP to EP, which would impact financials through 2019 US Viagra sales were $1.3B in 2015 (generic in Dec. 2017), and US Lyrica sales were $2.7B in 2015 (generic in Dec. 2018). Combined, the $3.9B represented 15% of IP 2015 revenues of $26.8B. If a shift is made pre-split ( ), IP earnings would step down in 2017 but its late-decade growth rate would accelerate. On the other hand, EP would experience a temporary step up in sales and profits s in 2017 (EP 2015 revenues would have been 18% higher than the $21.6B reported if they had been part of EP), but then suffer negative trends through 2019, similar to its EBITA margin declining from low 50% in 2014 to 36% in 4Q:15 (Exhibit 1), 1 partly due to the patent expirations of Celebrex, Zyvox, and EU Lyrica. Ian Read stated, "...we would expect that we would continue with our policy to move products like Viagra and Lyrica as they get close to be peri-loes from one business to the other. The exact timing we would decide, but in general you clearly want to have an innovative company that is focused on growth and not focused on managing the end cycles of products like Lyrica and Viagra." We continue to think that merging EP with another entity, if possible, could create the most value for shareholders Such action could make exit accretive plus offer tax advantages if the partner is domiciled ex-us. Ian Read stated, "There are many factors we'll take into account in whether we want to split or not, and one of them is of course the tax structure of the two companies if they are split. And I think the Treasury action and the government's willingness to act in this area will make us think deeply about what are the alternatives to let part of this Company if possible have a different tax jurisdiction." It is unclear, however, what partner would be the best fit and what company could effectively integrate and grow EP given its size and complexity ($25B revenues global company). Redomiciling EP ex-us would be the best case scenario in order to access trapped cash to pay a large dividend, but we do not know if Pfizer can make such a transaction happen. 4

5 Pfizer business segments P&L analysis We allocated corporate expenses according to estimates provided in Pfizer's earnings reports. Exhibit 1: Pfizer Innovative Products (IP) and Established Products (EP) P&L ($M) 2013A 2014A 1Q:15A 2Q:15A 3Q:15A 4Q:15A 2015A 1Q:16A Revenues 51,451 49,407 10,864 11,853 12,087 14,047 48,851 13,006 Innovative Products (IP) 23,602 24,005 5,739 6,630 6,752 7,637 26,758 7,034 Established Products (EP) 27,617 25,149 5,014 5,090 5,219 6,264 21,587 5,972 Expenses 29,998 30,012 6,762 7,226 7,109 9,899 30,996 7,656 Innovative Products (IP) 16,469 17,737 4,298 4,469 4,321 5,750 18,837 4,512 Established Products (EP) 13,371 12,087 2,374 2,654 2,687 4,032 11,748 3,144 EBITA 21,453 19,395 4,102 4,627 4,978 4,148 17,855 5,350 Innovative Products (IP) 7,133 6,268 1,441 2,161 2,431 1,887 7,921 2,522 Established Products (EP) 14,246 13,062 2,640 2,436 2,532 2,232 9,839 2,828 EBITA margin 41.7% 39.3% 37.8% 39.0% 41.2% 29.5% 36.5% 41.1% Innovative Products (IP) 30.2% 26.1% 25.1% 32.6% 36.0% 24.7% 29.6% 35.9% Established Products (EP) 51.6% 51.9% 52.6% 47.9% 48.5% 35.6% 45.6% 47.3% Other (income)/deductions, net (estimated) 321 (417) (133) (121) (57) 31 (281) (118) Innovative Products (IP) 122 (499) (165) (154) (84) (40) (443) (47) Established Products (EP) (71) Pre-tax income (estimated) 21,132 19,812 4,235 4,748 5,035 4,117 18,136 5,468 Innovative Products (IP) 7,011 6,766 1,606 2,316 2,515 1,927 8,363 2,569 Established Products (EP) 14,045 12,977 2,608 2,402 2,507 2,160 9,676 2,899 Pre-tax income margin (estimated) 41.1% 40.1% 39.0% 40.1% 41.7% 29.3% 37.1% 42.0% Innovative Products (IP) 29.7% 28.2% 28.0% 34.9% 37.2% 25.2% 31.3% 36.5% Established Products (EP) 50.9% 51.6% 52.0% 47.2% 48.0% 34.5% 44.8% 48.5% YOY 2013A 2014A 1Q:15A 2Q:15A 3Q:15A 4Q:15A 2015A 1Q:16A Revenues -4.0% -3.8% -6.7% -1.7% 7.1% -1.1% 19.7% Innovative Products (IP) 1.7% 9.3% 8.2% 12.5% 15.2% 11.5% 22.6% Established Products (EP) -8.9% -16.3% -21.8% -16.3% -2.2% -14.2% 19.1% Expenses 0.0% 2.2% -3.9% -3.1% 15.9% 3.3% 13.2% Innovative Products (IP) 7.7% 10.3% 0.8% 0.6% 12.5% 6.2% 5.0% Established Products (EP) -9.6% -11.5% -12.7% -10.3% 19.7% -2.8% 32.4% EBITA -9.6% -12.3% -10.7% 0.3% -9.3% -7.9% 30.4% Innovative Products (IP) -12.1% 6.5% 27.7% 42.7% 24.4% 26.4% 75.0% Established Products (EP) -8.3% -20.2% -29.8% -22.0% -26.6% -24.7% 7.1% Pre-tax income (estimated) -6.2% -13.6% -9.3% 0.7% -11.9% -8.5% 29.1% Innovative Products (IP) -3.5% 3.3% 28.5% 40.2% 19.3% 23.6% 60.0% Established Products (EP) -7.6% -21.7% -29.7% -21.4% -28.9% -25.4% 11.2% Source: Company reports, Morgan Stanley Research 5

6 Valuation methodology and risks PFE.N Valuation Methodology Our $36 PT represents 13x base case 2017E EPS of $ x '17 P/E is slightly below the Major Pharma peer group median 15x, because we project PFE 3-yr CAGR EPS growth of 10% vs. group median of 14%. Risks to Achieving Price Target Upside: Core business upside, positive pipeline developments, and/or external transactions which boost shareholder value. Downside: Revenue shortfalls cause EPS misses, P/E contracts due to pipeline disappointments, and/or Pfizer overpays for potential acquisitions. Exhibit 2: Major Pharma Comp Sheet Global BioPharma Consensus Comp Sheet May 3, 2016 U.S. Major Pharma Ticker Company name Curr. Price Price performance P/E EV/EBITDA EV/Revenue EPS Growth (%) 2015A 2016 Ytd 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E '16-'20E ABBV Abbvie $ % 4% 12.8x 10.7x 10.8x 9.4x 4.8x 4.4x 13% 19% 17% BMY Bristol-Myers Squibb $ % 3% 28.3x 22.5x 23.3x 18.0x 6.6x 6.0x 32% 26% 23% JNJ Johnson & Johnson $ % 10% 17.1x 16.1x 11.8x 11.1x 4.1x 3.9x 7% 6% 6% LLY Eli Lilly $ % -10% 21.4x 19.2x 14.3x 13.1x 4.1x 3.9x 4% 11% 12% MRK Merck $ % 4% 14.8x 14.6x 8.6x 8.7x 4.2x 4.2x 4% 2% 5% PFE Pfizer $ % 4% 14.3x 13.2x 10.0x 9.4x 4.3x 4.2x 8% 9% 7% Market Cap Weighted Average 2% 5% 17.4x 15.7x 12.4x 11.2x 4.6x 4.3x 10% 10% 10% Mean 4% 3% 18.1x 16.0x 13.1x 11.6x 4.7x 4.4x 11% 12% 12% Median 1% 4% 16.0x 15.3x 11.3x 10.3x 4.3x 4.2x 7% 10% 10% EU Major Pharma Ticker Company name Curr. Price Price performance P/E EV/EBITDA EV/Revenue EPS Growth (%) 2015A 2016 Ytd 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E '16-'20E AZN Astrazeneca $ % -15% 14.3x 14.8x 10.3x 10.4x 3.5x 3.5x -7% -3% 2% BAYN-XE Bayer % -15% 13.6x 12.4x 9.0x 8.5x 2.1x 2.0x 4% 10% 8% GSK-LN Glaxosmithkline GBp 1,472 0% 7% 17.0x 16.2x 9.7x 9.2x 3.2x 3.1x 14% 5% 7% NVS Novartis $ % -12% 15.8x 14.5x 15.0x 14.1x 4.2x 4.1x -3% 9% 6% NOVO'B-KO Novo Nordisk DKK % -12% 23.0x 20.6x 16.6x 15.3x 7.7x 7.1x 15% 12% 13% RHHBY-5 Roche SFr % -13% 16.3x 14.9x 10.5x 9.8x 4.3x 4.1x 4% 9% 8% SAN-FR Sanofi % -9% 13.0x 12.7x 8.4x 8.3x 2.7x 2.6x -1% 2% 5% Market Cap Weighted Average 8% -10% 16.5x 15.3x 11.8x 11.2x 4.2x 4.0x 4% 7% 7% Mean 8% -10% 16.1x 15.2x 11.4x 10.8x 3.9x 3.8x 4% 6% 7% Median 2% -12% 15.8x 14.8x 10.3x 9.8x 3.5x 3.5x 4% 9% 7% Global Mean 17.0x 15.6x 12.2x 11.2x 4.3x 4.1x 7% 9% 9% Global Median 15.8x 14.8x 10.5x 9.8x 4.2x 4.1x 4% 9% 7% U.S. Biotech Ticker Company name Curr. Price Price performance P/E EV/EBITDA EV/Revenue EPS Growth (%) 2015A 2016 Ytd 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E '16-'20E ALXN Alexion $ % -24% 28.6x 21.9x 25.2x 19.5x 11.4x 9.3x 2% 30% 20% AMGN Amgen $ % -4% 14.1x 12.9x 9.2x 8.6x 5.3x 5.1x 10% 10% 8% BIIB Biogen $ % -11% 14.5x 13.6x 10.5x 9.9x 5.6x 5.3x 13% 7% 9% CELG Celgene $ % -14% 18.1x 14.7x 15.0x 12.3x 8.3x 7.0x 20% 24% 22% GILD Gilead $ % -14% 7.2x 7.0x 6.0x 6.2x 4.2x 4.3x -1% 2% 1% INCY Incyte $ % -34% NM NM NM NM 15.5x 11.5x 203% 592% 98% REGN Regeneron $ % -32% 32.4x 22.8x 21.8x 17.8x 8.3x 7.0x -9% 42% 21% VRTX Vertex $ % -35% 70.0x 23.3x 44.7x 17.3x 11.0x 7.7x 205% 200% 51% Market Cap Weighted Average 8% -15% 17.5x 13.3x 12.8x 10.4x 6.8x 6.0x 21% 40% 15% Mean 12% -21% 26.4x 16.6x 18.9x 13.1x 8.7x 7.2x 55% 113% 29% Median 6% -19% 18.1x 14.7x 15.0x 12.3x 8.3x 7.0x 12% 27% 20% Source: Company Data, Thomson Reuters, Morgan Stanley Research ; For valuation methodology and risks associated w ith any price targets referenced in this research report, please contact the Client Support Team as follow s: US/Canada ; Hong Kong ; Latin America (U.S.); London +44 (0) ; Singapore ; Sydney +61 (0) ; Tokyo +81 (0) Alternatively you may contact your investment representative or Morgan Stanley Research at 1585 Broadw ay, (Attention : Research Management), New York, NY USA. 6

7 Exhibit 3: Consensus Next Twelve Month (NTM) P/E Pfizer May 5, 2016 Consensus NTM P/E 18x 16x 14x 12x 10x 8x 6x 4x 14.6x 13.9x 12.3x 10.0x PFE NTM P/E 5-yr Mean P/E +1 StDev -1 StDev Source: Thomson Reuters, Morgan Stanley Research Exhibit 4: PFE Consensus NTM P/E vs. US Major Pharma average 25x 20x Consensus NTM P/E 15x 10x 5x 17.2x 13.9x x PFE NTM P/E U.S. Major Pharma Mean U S Major Ph arma in clu des AB B V, B MY, LLY, JNJ, MRK an d PFE Source: Thomson Reuters, Morgan Stanley Research 7

8 Financials Exhibit 5: Income Statement, Margins & Valuation Income Statement ($M ) E 2017E 2018E 2019E 2020E Net sales 51,452 49,406 48,850 52,930 55,769 58,008 58,951 63,492 COGS 9,273 9,134 9,021 11,136 11,712 12,182 12,380 13,143 Gross Profit 42,179 40,272 39,829 41,794 44,058 45,827 46,571 50,349 SG&A 14,172 13,721 14,324 14,425 14,714 14,861 15,232 16,146 R&D 6,554 7,153 7,652 7,729 7,899 8,065 8,267 8,763 EBITA 21,453 19,398 17,853 19,640 21,445 22,901 23,072 25,441 EBITDA 23,264 20,896 19,282 21,040 22,945 24,401 24,572 26,941 Other expenses (income) 325 (415) (279) (368) (11) (223) Pre-tax Income 21,128 19,813 18,132 20,008 21,000 22,659 23,084 25,664 Taxes 5,810 5,250 4,351 4,794 5,040 5,438 5,540 6,159 Tax rate 27.5% 26.5% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% Net Income 15,288 14,531 13,754 15,180 15,928 17,191 17,516 19,479 Diluted Non-GAAP EPS $2.22 $2.26 $2.20 $2.46 $2.67 $2.98 $3.13 $3.58 Dil. Sh. Outstd. 6,894 6,424 6,257 6,165 5,968 5,777 5,604 5,436 % Growth YOY E 2017E 2018E 2019E 2020E Net Sales -13% -4% -1% 8% 5% 4% 2% 8% COGS -16% -1% -1% 23% 5% 4% 2% 6% Gross Profit -12% -5% -1% 5% 5% 4% 2% 8% SG&A -13% -3% 4% 1% 2% 1% 2% 6% R&D -11% 9% 7% 1% 2% 2% 2% 6% EBITA -12% -10% -8% 10% 9% 7% 1% 10% EBITDA -13% -10% -8% 9% 9% 6% 1% 10% Net Income -7% -5% -5% 10% 5% 8% 2% 11% Diluted EPS 1% 2% -3% 12% 8% 12% 5% 15% Margin Analysis E 2017E 2018E 2019E 2020E Gross margin 82.0% 81.5% 81.5% 79.0% 79.0% 79.0% 79.0% 79.3% SG&A as % of Sales 27.5% 27.8% 29.3% 27.3% 26.4% 25.6% 25.8% 25.4% R&D as % of Sales 12.7% 14.5% 15.7% 14.6% 14.2% 13.9% 14.0% 13.8% EBITA margin 41.7% 39.3% 36.5% 37.1% 38.5% 39.5% 39.1% 40.1% EBITDA margin 45.2% 42.3% 39.5% 39.8% 41.1% 42.1% 41.7% 42.4% Net M argin 29.7% 29.4% 28.2% 28.7% 28.6% 29.6% 29.7% 30.7% Gross Margin (bps change) 62 (47) 2 (257) Op. Margin (bps change) 39 (243) (272) (34) 93 Valuation E 2017E 2018E 2019E 2020E Price/Earnings 13.8x 13.8x 14.7x 13.7x 12.6x 11.3x 10.8x 9.4x EV/EBITDA 8.8x 9.5x 11.3x 10.7x 9.7x 9.0x 8.7x 7.9x EV/Sales 4.0x 4.0x 4.5x 4.3x 4.0x 3.8x 3.6x 3.3x Dividend / Share $0.96 $1.04 $1.12 $1.20 $1.20 $1.20 $1.20 $1.20 Dividend Yield 3.1% 3.3% 3.5% 3.6% 3.6% 3.6% 3.6% 3.6% FCF / Share $2.40 $2.44 $2.10 $2.09 $2.73 $2.64 $3.29 $2.86 FCF Yield 7.8% 7.8% 6.5% 6.2% 8.1% 7.8% 9.8% 8.5% Source: Morgan Stanley Research, Company Data 8

9 Exhibit 6: Balance Sheet & Cash Flow Pfizer May 5, 2016 Balance Sheet ($M ) E 2017E 2018E 2019E 2020E Cash and short-term investments 32,408 36,122 23,291 26,062 24,303 22,894 22,708 24,622 A/R 9,357 8,669 8,176 9,467 9,123 10,214 9,437 11,727 Inventory 6,166 5,663 7,513 8,395 8,336 9,067 8,618 10,157 Other current assets 8,313 7,248 4,825 4,825 4,825 4,825 4,825 4,825 PP&E 12,397 11,762 13,766 13,566 13,266 12,966 12,666 12,366 Other intangibles, net 39,385 35,166 40,356 36,471 32,691 29,025 25,639 23,220 Other assets 64,075 64,644 69,534 69,534 69,534 69,534 69,534 69,534 TOTAL ASSETS 172, , , , , , , ,451 Total debt 36,489 36,682 38,978 42,244 37,330 33,616 27,711 26,578 A/P and Accrued liabilities 3,234 3,440 3,620 3,804 4,004 4,117 4,136 4,626 Other current liabilities 14,105 13,049 15,619 15,619 15,619 15,619 15,619 15,619 Other non-current liabilities 41,653 44,481 44,245 44,245 44,245 44,245 44,245 44,245 Total Liabilities 95,481 97, , , ,197 97,597 91,711 91,068 S/E 76,620 71,621 64,998 62,408 60,879 60,928 61,715 65,383 TOTAL LIABILITIES AND S/E 172, , , , , , , ,451 Cash Flow Statement ($M ) E 2017E 2018E 2019E 2020E Net income 22,072 9,168 6,986 10,805 11,631 12,979 13,510 16,189 D&A 6,410 5,537 5,157 5,285 5,280 5,166 4,886 3,919 Change in working capital (3,392) 1, (1,990) 604 (1,709) 1,244 (3,339) Other operating activities (7,325) 754 1, CASH FROM OPERATIONS 17,765 16,883 14,512 14,101 17,515 16,436 19,640 16,768 Net Capex (1,206) (1,199) (1,397) (1,200) (1,200) (1,200) (1,200) (1,200) Other investing activities (incl. M &A) (9,419) (4,455) (1,583) (2,351) 3,000 2,000 1,000 (2,000) CASH FROM INVESTING (10,625) (5,654) (2,980) (3,551) 1, (200) (3,200) Cash dividends paid (6,580) (6,609) (6,940) (7,396) (7,159) (6,930) (6,722) (6,521) Net change in debt 6, ,306 3,266 (4,915) (3,714) (5,904) (1,133) Other financing activities (incl. Share Repurchases) (14,431) (3,926) (4,599) (6,000) (6,000) (6,000) (6,000) (6,000) CASH FROM FINANCING (14,975) (9,986) (10,233) (10,130) (18,074) (16,644) (18,627) (13,654) Exchange rate effect (63) (83) (1,000) Net change in cash (7,898) 1, , (86) Other M etrics E 2017E 2018E 2019E 2020E LEVERAGE: Net Debt 4, ,687 16,183 13,027 10,721 5,004 1,956 Debt / EBITDA 1.6x 1.8x 2.0x 2.0x 1.6x 1.4x 1.1x 1.0x Net Debt / EBITDA 0.2x 0.0x 0.8x 0.8x 0.6x 0.4x 0.2x 0.1x PROFITABILITY: ROE 19.4% 19.7% 20.2% 23.9% 26.0% 28.4% 28.7% 30.8% RN OA 17.5% 17.3% 16.0% 16.8% 19.2% 21.5% 22.8% 25.9% LIQUIDITY: Current Ratio Quick Ratio OPERATIONAL EFFICIENCY: Days Receivable Days Payable Days Inventory Source: Morgan Stanley Research, Company Data 9

10 Disclosure Section The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. LLC, and/or Morgan Stanley C.T.V.M. S.A., and/or Morgan Stanley Mexico, Casa de Bolsa, S.A. de C.V., and/or Morgan Stanley Canada Limited. As used in this disclosure section, "Morgan Stanley" includes Morgan Stanley & Co. LLC, Morgan Stanley C.T.V.M. S.A., Morgan Stanley Mexico, Casa de Bolsa, S.A. de C.V., Morgan Stanley Canada Limited and their affiliates as necessary. For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, USA. For valuation methodology and risks associated with any recommendation, rating or price target referenced in this research report, please contact the Client Support Team as follows: US/Canada ; Hong Kong ; Latin America (U.S.); London +44 (0) ; Singapore ; Sydney +61 (0) ; Tokyo +81 (0) Alternatively you may contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY USA. Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: David Risinger. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts. Global Research Conflict Management Policy Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at Important US Regulatory Disclosures on Subject Companies As of April 29, 2016, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: Abbvie Inc., Bristol-Myers Squibb Co. Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Abbvie Inc., Eli Lilly & Co.. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. An employee, director or consultant of Morgan Stanley is a director of Merck & Co., Inc.. This person is not a research analyst or a member of a research analyst's household. Morgan Stanley & Co. LLC makes a market in the securities of Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Morgan Stanley trades or may trade as principal in the debt securities (or in related derivatives) that are the subject of the debt research report. Certain disclosures listed above are also for compliance with applicable regulations in non-us jurisdictions. STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Global Stock Ratings Distribution (as of April 30, 2016) The Stock Ratings described below apply to Morgan Stanley's Fundamental Equity Research and do not apply to Debt Research produced by the Firm. For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively. 10

11 COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC) STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL IBC % OF RATING CATEGORY Overweight/Buy % % 25% Equal-weight/Hold % % 23% Not-Rated/Hold 78 2% 7 1% 9% Underweight/Sell % 91 13% 13% TOTAL 3, Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months. Analyst Stock Ratings Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months. Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index. Stock Price, Price Target and Rating History (See Rating Definitions) Important Disclosures for Morgan Stanley Smith Barney LLC Customers 11

12 Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC or Morgan Stanley or any of their affiliates, are available on the Morgan Stanley Wealth Management disclosure website at For Morgan Stanley specific disclosures, you may refer to Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by the same person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest. Other Important Disclosures Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Abbvie Inc., Bristol-Myers Squibb Co, Eli Lilly & Co., Merck & Co., Inc., Pfizer Inc. Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Matrix at Morgan Stanley Research is provided to our clients through our proprietary research portal on Matrix and also distributed electronically by Morgan Stanley to clients. Certain, but not all, Morgan Stanley Research products are also made available to clients through third-party vendors or redistributed to clients through alternate electronic means as a convenience. For access to all available Morgan Stanley Research, please contact your sales representative or go to Matrix at Any access and/or use of Morgan Stanley Research is subject to Morgan Stanley's Terms of Use ( By accessing and/or using Morgan Stanley Research, you are indicating that you have read and agree to be bound by our Terms of Use ( In addition you consent to Morgan Stanley processing your personal data and using cookies in accordance with our Privacy Policy and our Global Cookies Policy ( including for the purposes of setting your preferences and to collect readership data so that we can deliver better and more personalized service and products to you. To find out more information about how Morgan Stanley processes personal data, how we use cookies and how to reject cookies see our Privacy Policy and our Global Cookies Policy ( If you do not agree to our Terms of Use and/or if you do not wish to provide your consent to Morgan Stanley processing your personal data or using cookies please do not access our research. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The value of and income from your investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company's securities/instruments. The fixed income research analysts, strategists or economists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts', strategists' or economists' compensation is not linked to investment banking or capital markets transactions performed by Morgan Stanley or the profitability or revenues of particular trading desks. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common equity securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities/instruments or derivatives of securities/instruments of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons. With the exception of information regarding Morgan Stanley, Morgan Stanley Research is based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel. Morgan Stanley Research personnel may participate in company events such as site visits and are generally prohibited from accepting payment by the company of associated expenses unless pre-approved by authorized members of Research management. Morgan Stanley may make investment decisions that are inconsistent with the recommendations or views in this report. To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives. Morgan Stanley is not incorporated under PRC law and the research in relation to this report is conducted outside the PRC. Morgan Stanley Research does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors shall have the relevant qualifications to invest in such securities and shall be responsible for obtaining all relevant approvals, licenses, verifications and/or registrations from the relevant governmental authorities themselves. Neither this report nor any part of it is intended as, or shall constitute, provision of any consultancy or advisory service of securities investment as defined under PRC law. Such information is provided for your reference only. Morgan Stanley Research is disseminated in Brazil by Morgan Stanley C.T.V.M. S.A.; in Mexico by Morgan Stanley México, Casa de Bolsa, S.A. de C.V which is regulated by Comision Nacional Bancaria y de Valores. Paseo de los Tamarindos 90, Torre 1, Col. Bosques de las Lomas Floor 29, Mexico City; in Japan by Morgan Stanley MUFG Securities Co., Ltd. and, for Commodities related research reports only, Morgan Stanley Capital Group Japan Co., Ltd; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents) and by Bank Morgan Stanley AG, Hong Kong Branch; in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number H), regulated by the Monetary Authority of Singapore (which accepts legal responsibility for its contents and should be contacted with respect to any matters arising from, or in connection with, Morgan Stanley Research) and by Bank Morgan Stanley AG, Singapore Branch (Registration number T11FC0207F); in Australia to "wholesale clients" within the meaning of the Australian Corporations Act by Morgan Stanley Australia Limited A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents; in Australia to 12

13 "wholesale clients" and "retail clients" within the meaning of the Australian Corporations Act by Morgan Stanley Wealth Management Australia Pty Ltd (A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Indonesia by PT Morgan Stanley Asia Indonesia; in Canada by Morgan Stanley Canada Limited, which has approved of and takes responsibility for its contents in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main and Morgan Stanley Private Wealth Management Limited, Niederlassung Deutschland, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the US by Morgan Stanley & Co. LLC, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized by the Prudential Regulatory Authority and regulated by the Financial Conduct Authority and the Prudential Regulatory Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited. The information in Morgan Stanley Research is being disseminated by Morgan Stanley Saudi Arabia, regulated by the Capital Market Authority in the Kingdom of Saudi Arabia, and is directed at Sophisticated investors only. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at Professional Clients only, as defined by the DFSA. The financial products or financial services to which this research relates will only be made available to a customer who we are satisfied meets the regulatory criteria to be a Professional Client. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA. As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided exclusively to persons based on their risk and income preferences by the authorized firms. Comments and recommendations stated here are general in nature. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations. The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley Research, or any portion thereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. INDUSTRY COVERAGE: Major Pharmaceuticals COMPANY (TICKER) RATING (AS OF) PRICE* (05/04/2016) David Risinger Abbvie Inc. (ABBV.N) O (11/02/2015) $61.46 Bristol-Myers Squibb Co (BMY.N) O (04/21/2015) $70.78 Eli Lilly & Co. (LLY.N) E (07/15/2015) $74.87 Merck & Co., Inc. (MRK.N) E (05/07/2014) $54.81 Pfizer Inc (PFE.N) E (04/07/2016) $33.40 Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted Morgan Stanley 13