The Investment Case for Sanofi-Aventis

I made a purchase in my tax-exempt account of Sanofi-Aventis (SNY) on Friday. I believe SNY represents a compelling value at the current price ($42 and change). The taxable account has exposure through the short put option. The effective weighting is around 5.7%.

Sanofi is a pharmaceutical company, based in France. Formed by several mergers, they have a sizable presence in several therapeutic categories such as thrombosis, the central nervous system, oncology, as well as vaccines.

As several of the drug companies have done poorly in recent years, I began this past summer trolling for interesting buys. Unfortunately, most of the companies that are cheap are facing looming patent expirations that will damage sales and potentially compress margins. Pfizer, for example, has significant exposure to two drugs, Lipitor and Norvasc, which together represent about half of their earnings. Norvasc went off patent this year, and has experienced significant sales declines, while Lipitor expires in 2010.

It will be virtually impossible for them to replace the sales from Lipitor, and that drug is what drives their impressive margins. Therefore, Pfizer, as an example, looks cheap, but once the windfall earnings from Lipitor are removed, it is actually expensive.

Sanofi also has significant patent exposure, but it is manageable. In addition, they have a solid pipeline. Their European franchise also makes the patent issue more manageable (European regulations with regards to expiring patents are more generous than in the US), and some of their drugs are far more complex and difficult to imitate than, say, a Lipitor. Add to that a healthy vaccine business, and this is a healthy company.

That said, I don't expect much topline growth - I am modeling a range of negative 2% to positive 4% through 2012. While modeling the sales contribution from pipeline drugs is challenging, we should expect 1 to 3 new launches per year, on average. The low topline growth is why the multiple has dropped - growth investors have dumped the stock and value investors haven't taken enough interest yet.

The low multiple on SNY is not justified. It is a cash generator, with a fairly predictable and diversified revenue stream, despite the uncertainty surrounding the patents and drug launches. I generally use a conservative multiple on drug companies (relative to their fantastic financial metrics) because of the risk associated with litigation, regulation, and government control over health care. Thus, I consider my valuation to be conservative.

I am not yet building a maximum position (7.5%+) because the valuation is not compelling enough for that. If it drops below $40, I might consider bumping up the position more.

Disclosure: Long SNY

Comments

[clear1]

Great summary...and with the current quotation at $35.5 (3/14/08), we believe it trades at a ~30% discount from our assessment of intrinsic value. The interesting item about this company is that all of the research we read indicates it has the "best" pipeline of the major pharmaceuticals...yet other comments (like yours) suggest a more sanguine outlook.