I have written two positive articles on pharmaceutical stocks in the past twelve months. Last year I wrote a positive thesis on the merits of Roche (OTCQX:RHHBY) due to its dominant position in cancer care and diagnostics. Roche continues to be my favorite European pharmaceutical company, although I would wait for a price pullback to the $50s before investing new capital. In the U.S., my preference has been for Merck (MRK), a company I featured this past February. I remain sanguine about Merck at the current price level.
Recently another U.S. pharmaceutical firm has pulled back to a price level I find very attractive - Bristol-Myers Squibb (BMY). On May 22nd, the stock spiked over 7% on a positive research note stating that Bristol's immunotherapy medicine Nivolumab, currently in Phase II trials, had strong cancer fighting capability. It had proven especially strong against melanoma, along with indications for renal and lung cancers. This news led to a price surge to nearly $50 a share. Since June 3, the price of BMY has fallen by 16%, offering a good opportunity to pick up one of the fastest growers in the industry. To build a strong case for Bristol, I examine nine key selection criteria, which include;
Key Selection Criteria
- A market capitalization over $10 billion.
- A leadership position within a growing industry.
- A dominant, or large, market share within its product mix.
- A strong position internationally.
- A strong balance sheet and high credit rating.
- A high free cash flow number.
- A low historical relative valuation as measured by price/sales and/or price/earnings ratios.
- A strong dividend growth rate.
- A catalyst of new revenue opportunities (pipeline).
Bristol is a large-cap healthcare firm with a current capitalization of $69 billion.
Bristol-Myers Squibb maintains a leadership position in many facets of the pharmaceutical arena. Although its large drug Plavix just lost patent protection, Bristol maintains strong positions in key pharma areas like cardiology and depression. Although many of its drugs in these areas have or will lose patent in the next few years, it is Bristol's strong leadership position in cancer care that I think allow this firm to be considered one of the top firms in its area of expertise. The pharmaceutical firm also has a compelling opportunity within the hepatitis C market.
Bristol Myers International Sales
Source: Bristol Myers Annual Report
International revenue has remained a large portion of Bristol's revenue and has continued to accelerate. It has risen from 37% of total sales to 42% in 2012. Bristol-Myers Squibb Co. has expanded an alliance with Simcere Pharmaceutical Group to develop and market a medicine treating rheumatoid arthritis in China.
The balance sheet of Bristol is in excellent condition. Bristol maintains a credit rating of A+ from Standard & Poor's Ratings Services. This rating was affirmed this past May. S&P commented "Considering U.S.-based pharmaceutical company Bristol-Myers Squibb's exceptional liquidity, we are raising our short-term rating on the company to 'A-1+' from 'A-1'. We are also affirming our 'A+' long-term corporate credit rating on the company. The long-term rating outlook is stable. The stable outlook reflects the company's improving operating performance and a strong financial risk profile for the rating, which provides some cushion for the expiration of key patents."
Bristol Myers FCF
Source: Bristol Myers Annual Report
As for relative valuation, I have a preference for price/sales ratio when examining the merits of a pharmaceutical company. Bristol Myers is trading toward the middle of its range in history in terms of price to sales. Bristol has traded at a price/sales ratio range of 1.9 to 5.8 in the past decade. The average price/sales ratio for the previous ten years has been 3.7.
Free cash flow generation by Bristol has been very strong. Free cash flow has grown from $3.3 billion to $6.3 billion in 2012. This is much higher than previous years and despite the loss of patents, Bristol has done an excellent job at managing expenses.
Sales per share have stagnated at Bristol Myers throughout the past decade due to the patent loss of key drugs over the years. Sales per share should bottom this year at 10. At current levels, Bristol Myers is thus selling at just over 4 times sales, higher than norm. But this sales per share analysis is cyclical in nature for Bristol. I expect sales per share to advance to 14 by 2016 as new key drugs advance revenue.
Bristol recently boosted its share-buyback authorization by $3 billion. The new authorization adds to the $3 billion program previously in place, which had about $340 million remaining. Buybacks have had a strong impact on share count as total share count has been reduced in the past five years from 2,001,000,000 shares to 1,635,000,000 shares. This is a total reduction of shares outstanding of nearly 18%. I expect continued buybacks to reduce share count by an additional 10% by 2016. This share account reduction will continue to allow Bristol to generate strong sales per share growth.
Price/Sales Ratio Avg.
Sales Per Share
Source: Bristol Myers Annual Report
With its continued stock buybacks, and new pharmaceutical products in cancer continuing to hit the market, I expect Bristol Myers sales per share to advance from just over 10 today to 14 by 2016. Based upon an above-average price/sales ratio of 4.25 (due to strong sales per share growth) my expected price for Bristol Myers would be $59.50 a share within a three-year time frame. This would result in a $17.50 capital gain profit based on today's price of $42 a share. Importantly, this does not include dividends, which will be an additional component in total return for BMY investors.
|2016 SPS Projected||14|
Dividends have remained very consistent for Bristol Myers over the preceding five years. Although the dividend growth rate has been below that of its competitors, this is no doubt due to the loss of income from patent expiration for key drugs like Plavix.
Bristol Myers Dividend Payout History - 5 Years
Dividends Per Share
Source: Bristol Myers Annual Report
Bristol currently pays out 70% of its earnings in dividends. This figure allows for modest dividend growth of 3% in the next few years. Dividend payments should be $1.45 in 2014, $1.50 in 2015 and $1.54 in 2016. This would result in an additional collection of $4.49 in dividends over the three-year period. Added to my target price based upon price/sales analysis ($59.50), appreciation from both capital gains and dividends could result in a total return of over 50%. This also does not include reinvested dividends. Building wealth through dividend growth and reinvestment of dividends is a strong methodology for outperforming the markets over time.
Bristol has been facing an unprecedented loss of revenue as it passes through its patent cliff. The genericization of Plavix (May 2012) and Avapro (March 2012) in the U.S. has resulted in significant loss of revenues over the past year. Avapro recorded a 52% decline in global net sales to $56 million in the second quarter of 2013. Global net sales of Plavix plummeted 94% to $44 million in the second quarter of 2013. U.S. sales of the drug plunged 97% to a mere $18 million.
Thus an investment in Bristol is not based upon a 2013's revenue growth but primarily a wager on its new products in the cancer arena that will drive 20% revenue growth through the end of the decade. Although many other firms have a strong cancer pipeline and new products forthcoming (Roche & Merck), Bristol could become the dominant player in cancer due to its multiple revolutionary product line in immunotherapy. Immunotherapy is treating cancer by either inducing, enhancing or suppressing an immune response to cancer within the body. The process of the immunotherapy is to elicit a stronger anti tumor response by removing the cancer resistance mechanism. Once the mechanism is lifted, the patient's internal immune response can be enough to eliminate the cancer cells.
According to Merrill Lynch, the potential revenue opportunity for the industry in immunotherapy is $35 billion by 2023. This could make this cancer market the largest revenue generator for many pharmaceutical firms, even more than the blockbuster statin category. This offers a tremendous opportunity for Bristol as it is currently in the lead position. Bristol recently demonstrated that its drugs in immunotherapy had a dramatic impact on survival results. The study results released in 2013 indicated that those patients that received Bristol's immunotherapy drug Yervoy and the treatment Nivolumab shrank tumors in a majority of study patients. Three out of four patients who responded to the dual treatment had tumor shrinkage in the first three months. The drugs work together attacking different parts of the immune system and slowing immune cells from attacking tumors.
The combination of drugs thus allows the immune system to better challenge and ultimately kill more tumor cells. Yervoy, or ipilimumab, was approved in 2011 and is one of the first cancer drugs to significantly extend survival in patients with advanced melanoma, the most deadly form of skin cancer. Nivolumab, which is now in late-stage testing, targets a protein called PD-1, or Programmed Death receptor, a new class of immune-system drugs that shows promise not only in melanoma but also in lung and kidney cancer. So far, Bristol-Myers is furthest ahead in its development of a PD-1 inhibitor, but my other favored U.S. pharmaceutical Merck recently won designation from the U.S. Food and Drug Administration as a "breakthrough therapy," which could speed development and regulatory review of their own competing product. Roche also has PD-1 products in development, which I discussed in my thesis article last year.
Bristol looks to have a robust competitive position in cancer beyond Yervoy. It maintains a plethora of additional novel and potent checkpoint inhibitors in development as well including CD137 and anti-KIR. Bristol's/Innate Pharma's Lirilumab (IPH2102/BMS-986015) is currently being tested in over 420 patients for both blood and solid tumors. Lirilumab is a fully human monoclonal antibody blocking interaction between killer-cell immunoglobulin-like receptors (KIR) on NK cells with their ligands. Bristol is testing its anti-KIR in combination with Nivolumab and Yervoy in solid tumors. Bristol expects new data in 2014 about the stability and magnitude of patient response for this combination trial.
Outside of the cancer area, Eliquis should be one of the largest revenue generators for Bristol over the next decade. Eliquis, also known as apixaban, is an oral factor Xa inhibitor. It is meant as a treatment to prevent stroke and embolism in patients with atrial fibrillation. It is a large market, with over 6 million people in both the U.S. and Europe who suffer from atrial fibrillation. Boehringer's Pradaxa and Bayer's (OTCPK:BAYRY) Xarelto were approved for the prevention of stroke on 10/19/10 and 11/4/11, respectively. These two products are Eliquis's primary competition. Co-marketer Pfizer (PFE) and Bristol demonstrated in a near 20,000 patient study that the new clot buster Eliquis lowered stroke risk by 21%, major bleeding by 31% and mortality by 11%. Eliquis has also shown a best-in-class safety rating while also demonstrating a statistically significant benefit on all-cause mortality. The positive study results allowed European regulators to stamp their approval on Eliquis last November. The FDA followed suit, approving Eliquis for reducing risk of stroke and blood clots in patients with atrial fibrillation in late December of last year. Sales have been slow to date in 2013, as many primary care doctors have not moved their patients to Eliquis. Bristol Myers and Pfizer are attempting to better educate primary physicians while also expanding the label. The FDA will consider the drug for a new indication - deep vein thrombosis (DVT) in adult patients who have had hip or knee replacement surgery. The decision for this indication should come in early 2014.
Bristol also has a promising pipeline drug within the hepatitis C field. This spring Bristol gained an inside regulatory track in the frantic race to get new interferon-free hepatitis C drugs to the FDA. The company announced the FDA has provided the coveted "breakthrough" status for a combination of Daclatasvir with two other direct-acting antivirals, asunaprevir and BMS-791325. Daclatasvir (DCV), or BMS-790052, is a hepatitis C virus replication complex inhibitor and is one of several molecules Bristol-Myers Squibb is studying for the potential treatment of the prevalent disease. Bristol also has multiple investigational compounds beyond Daclatasvir, including an NS3 inhibitor and an NS5B nucleotide polymerase inhibitor. Bristol will start a phase 3 study of Daclatasvir, Asunaprevir and BMS-791325 in a fixed-dose coformulation by the end of 2013. Bristol also will be conducting a Phase II clinical trial of Daclatasvir combined with Merck's investigational MK-5172 for hepatitis C. This past April, the trial results for a combination of Gilead's (GILD) Sofosbuvir and Daclatasvir were released. The drug combination cleared 100% of the virus among 40 patients who had already failed the two other leading therapies. But Gilead decided not to utilize the successful combination as it is leading to market its own internal product combination. Physicians could eventually utilize Daclatasvir off label with Gilead's drug, or Daclatasvir could demonstrate efficacy with either of the Phase III or Phase II trials that are currently ongoing. As the market for hepatitis C drugs is due to explode beyond $15 billion in annual sales within several years, any success for Bristol in this area could only add to its prominent cancer product portfolio.
Bristol-Myers Squibb has had some setbacks. Bristol's Onglyza recently failed to beat placebo in a key outcomes trial (SAVOR). Although Onglyza won't become the blockbuster $5 billion drug, the drug should be a consistent $1-2 billion dollar drug until patent expiration in 2021. Other large products that will be revenue producers throughout the balance of the decade are Orencia and Forxiga.
Overall, Bristol Myers provides an investor with one of the highest growth prospects in all of pharma. It maintains a modest 4x price/sales ratio based upon trough sales. The firm also provides "yield support" as the dividend is fully covered and at an above market rate. The revenue growth from 2015 and beyond should be at the high end within the healthcare sector as total pharmaceutical sales could approach $30 billion by 2020. This would be a near double from the current year's depressed sales totals. Bristol Myers could easily approach $80 a share by the end of the decade.