Why Bristol-Myers Is Not Overvalued

Oct.30.11 | About: Bristol-Myers Squibb (BMY)

Many analysts have issued conservative ratings for Bristol-Myers (NYSE:BMY) due to the drug-maker's noticeable premium to competitors. While Bristol trades at 15.7x forward earnings, Pfizer (NYSE:PFE) trades at only 8.8x forward earnings, Sanofi (NYSE:SNY) at 8.4x, Eli Lilly & Co. (NYSE:LLY) at 10.4x, and Merck & Co. (NYSE:MRK) at 9.1x. At the same time, Bristol also offers the lowest dividend yield - a still large 4%. At first glance, Bristol may appear overvalued. However, given its fundamentals, strong portfolio, and stellar management, I believe that the pharmaceutical company is actually undervalued. Here is why.

YERVOY is a catalyst that has not been fully appreciated by the market, in my view. The treatment for metastatic melanoma is headed for solid growth and was recently launched in Europe during 2Q. Accounts ordering YERVOY is accelerating month by month. This has nevertheless been challenged by a poor return policy that can be changed going forward.

During the third quarter earnings call, CEO Lamberto Andreotti noted:

So with that, let's go back to the subject of this call. We have just completed another very good quarter with strong sales, solid financials and significant R&D and business development achievements. In short, we proved that once again, that our BioPharma strategy is on track, delivering results today, while building a sound foundation for tomorrow.

With third quarter net sales of $5.3 billion, we delivered an 11% increase over last year. That is double-digit growth for the second straight quarter. We also reported non-GAAP EPS of $0.61 in the quarter compared to $0.59 a year ago. Our top line performance was strong across a wide range of products. This includes, of course, YERVOY, our breakthrough treatment for metastatic melanoma, which in only its second quarter on the market, had worldwide sales of $121 million. I note that sales should have been $148 million instead of $121 million if we have not changed our returns policy.

Bristol is also having strong Phase III test results for ELIQUIS. The drug has shown to have statistical superiority to warfarin and reduces the risk of strokes and bleeding. While this development will help generate high risk-adjusted returns, the drug has already been launched in Europe for venous thromboembolic events and provides a solid stream of free cash flow.

It is also important to note that Bristol has the strongest portfolio and pipeline than competitors. Moreover, Bristol has achieved an economy of scale unmatched by its competitors. Its cost of goods are the lowest among peers, resulting in the highest gross profits. But perhaps the most significant metric at this stage of the game in BioPharma is R&D and Bristol is second only to Merck & Co here. Bristol cannot afford to rest on its laurels and must continue to innovate in order to preserve its premium. Several factors make me confident that the firm will prove its worth.

First, one should take a look at the geographical breakdown of sales for pharmaceuticals. It is striking how approximately two-thirds of 1H11 sales came from the United States for Bristol, while only about 42% of sales came from the United States for the peer group average. Put differently, expansion into emerging economies remains very much a catalyst for Bristol.

Second, Bristol has an opportunity to trim SG&A as it remains above the peer group average. For example, I anticipate that Bristol will spend nearly 4 times as much of its percent of revenue on SG&A than Merck & Co will by the end of 2011. Acquiring companies, like Amira Pharmaceuticals, will help Bristol increase scale and spread overhead across greater assets. The company has already down a stellar job on the analogous task for pipeline efficiency, so I see litte reason to doubt success here. While skepticism is always warranted, the CEO has noted several key management changes that indicate it is committed to this task.

And on the macro side, pharmaceuticals provide strong defensive plays during recessions. With looming fears over a double dip, the industry offers a nice shelter from the storm with dividend yields in the 4% - 5.1% range and low betas. Moreover, EMs are, in my belief, reducing the pressures of input inflation and healthcare reform more than what investors have appreciated. Improvements to pipeline management and productivity also remain in place for all of the major industry players. Bristol, Sanofi and Eli Lilly stand to gain the most momentum here.

Consensus estimates for EPS are that it will grow by 6% to $2.29 and then decline by 10.5% and then by 1.5% more in the following two years. I find that these numbers set the bar very low, as I anticipate revenue to grow by 11.9% in 2011 to $21.8B and then to decline by only 9% in the next year. As the company has a beta of 0.56 and sells products with inelastic demand, it remains a safe bet with high upside from YERVOY, ELIQUIS, and NUJOLIX.

To read my relatively bearish take on competitor Johnson & Johnson (NYSE:JNJ), click here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.