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Schwab, Pfizer fail the Clean Stocks test
Troubles at the board and management level keep these troubled companies from making the grade. Phelps Dodge may be clean -- but it's not a buy, either.
By Jim Jubak
In my last Clean Stocks column, I decided to apply the Clean Stock rules to three companies facing real or potential troubles: Pfizer (PFE, news, msgs), Charles Schwab Corp. (SCH, news, msgs), and Phelps Dodge (PD, news, msgs).
In a minute I'll share with you what the Clean Stock model tell us about the likely future of these three stocks, but first a little background is in order for those unfamiliar with my Clean Stocks portfolio.
Since I started the list on Aug. 1, 2003, the average gain for the 11 stocks in the list is 21%, against a 21% gain for the S&P 500 Index ($INX). The relative performance of the portfolio has been even better in 2004, with the Clean Stocks gaining 13.8% and the S&P gaining 9%. (All performance is price appreciation only.) To read about the eight rules for picking Clean Stocks and to see the full 11-stock portfolio with full performance numbers, follow this link.
Now, onto this column's choices.
For Pfizer, the body blows just keep on coming
You're undoubtedly aware of the company's problem with its flagship Celebrex pain-killer.
But that's only the most publicized of the company's recent problems.
Here's another. Pfizer turned in a surprisingly weak performance in defense of Lipitor in a key patent trial that ended in December. Indian generic-drug maker Ranbaxy Laboratories (RBXZF, news, msgs) had been given almost no chance of overturning Pfizer's two patents, which protect the market leader for cholesterol-lowering drugs until 2009 and 2011 -- that is, until Ranbaxy came up with an unexpectedly convincing argument that claimed Pfizer botched its original lab work and then submitted statistically insignificant data to support its patent application. A trial that looked like a certain win isn't certain any more. Lipitor is Pfizer's best-selling drug with 2003 sales of $9.2 billion.
And then there's this: On Jan. 3, Pfizer got very mixed news from regulators on its new drug Lyrica. On the plus side, the U.S. Food & Drug Administration approved Lyrica to treat persistent nerve pain. On the negative side, Lyrica can be sold only as a controlled substance subject to the rules of the Drug Enforcement Administration. That's a big setback for Pfizer, which had hoped to sell Lyrica as a replacement for its fourth-biggest seller, Neurontin ($2.7 billion in 2003 sales). With that controlled substance tag, Lyrica will be harder to advertise and harder for doctors to dispense than the generics that have already gobbled up 25% of the market.
The big question for investors is this: What links these and other Pfizer problems?
The issue at Pfizer may not be its science but a management team that feels so much pressure to produce sales it has put marketing ahead of science. That's certainly how I read the Cox-2 debacle at Merck (MRK, news, msgs) and Pfizer: Merck and Pfizer tried to expand the addressable market beyond those patients for whom the reward of taking the Cox-2 drugs clearly justified the risk. And that's where they got into trouble.
Applying the Clean Stock test leaves me with considerable worries about Pfizer, particularly about what the big compensation package awarded to CEO Hank McKinnell may be signaling about the Pfizer board of directors. Here's what McKinnell made in 2003: A salary of $2 million plus a bonus of $4.6 million plus 1 million Pfizer options plus a payout of $2.8 million from the Pfizer long-term incentive plan for earlier years, plus $250,000 in matching payments for the Pfizer retirement plan.
Related news and commentary on MSN Money
Since McKinnell joined the company in January 2001, the size of his compensation package has gone up even when the company's stock has gone down. Initially, in 2001, he earned a $1.5 million salary and a $2.8 million bonus. In 2002, the salary increased to $1.8 million and the bonus to $3.5 million. And I've already supplied his 2003 compensation. How, you may wonder, did Pfizer's stock perform during that same period? A loss of 13% in 2001, a loss of 22% in 2002 and then a gain of 18% in 2003, followed by a 15% loss in 2004.
At some price, Pfizer will be cheap enough so that I'll be willing to buy it despite my concerns. But the shares aren't there yet.
Charles Schwab Corp.: When the founder comes back as savior
I've got two big Clean Stocks problems with this company.
First, there's the huge compensation package that Charles Schwab Corp. handed out to departing CEO David Pottruck. As CEO, Pottruck received a salary of $1 million for 2003 plus a bonus of $4.7 million. As a departing CEO asked to resign by the board of directors, he signed a new 30-month contract that calls for a $6.2 million lump-sum payment and a pay raise to $1.6 million annually. In addition, he gets to keep 365,000 shares, even though they aren't supposed to vest until 2008, and a 2003 award of 1.4 million options at an exercise price of $8.88 a share. His duties? They're unspecified.
Second, Charles Schwab to the rescue? The board has got to be kidding. Pottruck served as sole CEO for just 14 months, and many of the company's problems were visible as far back as 2000 when Pottruck and Schwab were co-CEOs. While Pottruck was CEO, Schwab was still chairman of the board. It's not clear how much power Schwab ever actually gave up to Pottruck. In 2003, when the board of directors made Pottruck sole CEO, it also voted to change the company's bylaws to give the chairman an active role in setting company strategy. That doesn't sound like the kind of independent board Charles Schwab Corp. needs to speed its recovery along, and it's not the kind of stock that makes it into the Clean Stocks portfolio.
Phelps Dodge: Can an active board head off trouble?
What's Phelps Dodge doing in the company of troubled names like Pfizer and Charles Schwab Corp.? After all, there's nothing "troubled" about the performance of its stock in the last two years. Shares climbed 140% in 2003 and another 31% in 2004. There's nothing about the compensation of CEO J. Steven Whisler that sends up an immediate red flag. He was paid a salary of $850,000 and a bonus of $1 million in 2003.
But in this case I'm interested in determining if the Clean Stocks formula can indicate if a company is nimble enough to take advantage of competitors' looming problems.
In recent years, Phelps Dodge has operated at a serious disadvantage to some of its foreign competitors who, because they have no mining operations in the United States, have not had to bear the production costs that stricter environmental laws require. In 2004, for example, the cost of environmental compliance at Phelps Dodge will be $35 million.
But environmental regulation has been catching up with mining companies operating overseas. For example, Newmont Mining (NEM, news, msgs) faces charges from the Indonesian government that it lied about how it was disposing of mine wastes that include arsenic, mercury and other heavy metals. Five company executives have been charged under Indonesian law and, if convicted, could face prison terms of up to 10 years.
I don't know the truth in the Indonesia case -- and the company denies the charges -- and I certainly don't know how the trial will come out. But the case is a leading indicator of a shift in global advantage: After years of paying the higher costs of protecting the environment in the United States, Phelps Dodge could be entering a period in which the efforts of foreign governments and citizens groups could seriously disrupt the operations of competitors. And It seems to me that the stability of U.S. environmental laws could be an advantage to Phelps Dodge in the coming decades as other countries assert their own environmental laws.
So in my Clean Stocks study of Phelps Dodge, I went looking for any signs that this old mining company might be able to learn new tricks for exploiting this advantage. I studied the board with that in mind -- and I came away disappointed. The board is composed of former mining and oil industry executives with a few directors who have chemical company, railroad, airline or technology backgrounds thrown in. It's a group that seems all too likely to confirm each other in the old ways of doing business and there isn't a single director that suggests the company is doing original thinking on these issues.
That's not a Clean Stock black mark. The stock doesn't make the list because of test no. 8 -- I don't see enough potential price appreciation ahead. A different board might have led me to a different conclusion, but at the moment I can't find a good reason to buy the stock.
And for my next Clean Stocks column, in about a month, I'll look at these three companies suggested by readers: American International Group (AIG, news, msgs), L-3 Communication Holdings (LLL, news, msgs), and Equifax (EFX, news, msgs).
If you've got a Clean Stock nominee, please send me an e-mail with the name of the stock and a few words telling me why you think it the company is worth studying.
New developments on past columns
Vicious cycle: Rising oil prices, falling dollar
Well, so much for that dollar rally. The Jan. 12 report that the U.S. trade deficit soared to a new, all-time monthly record of $60.3 billion in November put an end to the dollar rally of the first days of 2005. The dollar sold off on the news, which was especially punishing since economists had expected the trade deficit to fall to $54 billion, reaching new five-week lows against the euro and the yen. Adding to the gloom was news that foreign buying of U.S. securities hit its low for 2004 in October at $48 billion, well below the $56 billion trade deficit recorded that month. The gap between foreign buying in October and the U.S. trade deficit raised worries that foreigners might not be willing to finance the U.S. trade deficit without higher U.S. interest rates. Economists were left puzzling over the November results.
Economic theory says that a falling dollar should result in a narrower trade deficit since U.S. exports get cheaper -- spurring foreign buying -- and U.S. imports get more expensive -- spurring domestic cutbacks in buying. China may be the biggest factor preventing reality from conforming to theory. Since that country's currency, the yuan, is pegged to the value of the dollar, a falling U.S. dollar doesn't make Chinese goods more expensive to U.S. consumers, or U.S. goods cheaper for Chinese buyers. The trade deficit with China climbed to $16.6 billion in November. But China's currency clearly isn't the only glitch in the theory: The trade deficit to Canada and Japan, the next two biggest deficits, climbed by about 25%. With the trade deficit not behaving as expected to reduce the deficit, economists are now speculating that the deficit may take a bigger-than-expected bite out of U.S. economic growth. Morgan Stanley, for example, cut its estimate of fourth-quarter growth in U.S. domestic product to 3.5% from 4%. Given economists' record in predicting the change in the trade deficit, you're certainly entitled to take these new projections with a grain of salt or two. But this number is real: The net asset position of the United States -- what we own abroad minus what foreigners own in the United States, including all investments in foreign and domestic securities -- is now a net debt of $2.4 trillion.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Berkshire Hathaway and Newmont Mining. He does not own short positions in any stock mentioned in this column.
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