Warren Buffett Buys Bristol-Myers Squibb, And So Should You

Mar. 03, 2021 9:30 AM ETBristol-Myers Squibb Company (BMY)BRK.A, BRK.B50 Comments

Summary

Bristol-Myers Squibb is a leading biotech company that continues to generate strong results despite the pandemic.
Shares are quite inexpensive and offer an above-average dividend yield.
Buffett seems to like the stock a lot, and there are good reasons for other investors to do so, too.
This idea was discussed in more depth with members of my private investing community, Cash Flow Kingdom. Get started today »

Article Thesis

Big pharma and biotech are sectors that are still inexpensive in the current market, where a lot of other stocks are expensive. One of the best biotech companies you can buy right now is Bristol-Myers Squibb (NYSE:BMY). The company provides a solid dividend yield, has a compelling growth outlook, and shares trade at a very inexpensive valuation. The fact that Buffett's Berkshire Hathaway (BRK.A) (BRK.B) has recently added to its existing position further underlines the fact that this is an attractive opportunity right now.

An Unloved Industry

2020 has been a strong year for stocks overall, despite the sell-off that occurred in spring. For the whole year, major indices were still up quite a lot, and the start to 2021 has given investors more of the same.

This has, however, also led to stretched valuations for many stocks, as well as for the market overall. There are, however, some pockets of the market that are still inexpensive. This includes some REITs, energy stocks including midstream, and pharma & biotech.

The last group is, in general, interesting for investors, as it combines several positive factors. First, pharma and biotech profit from a trend of growing healthcare spending in many countries. Healthcare expenditures as a percentage of GDP have been growing in the US, in China, and so on. This means that healthcare spending, overall, must be growing at a faster rate than the economy overall, which is great for the companies that operate in this industry.

Healthcare spending also is not cyclical or vulnerable to economic downturns, as patients still require medical care even during a recession. This makes pharma and biotech companies resilient versus recessions, which results in below-average volatility and solid dividend growth streaks in many cases. The fact that many of the major pharma and biotech companies are still trading at inexpensive valuations, despite these attractive characteristics, can likely be explained by the fact that the market doesn't care too much about this industry right now.

It is neither new and shiny, like many of the tech or EV stocks, nor is it a favorite of the reopening trade, like airlines or hospitality. Healthcare overall, and big pharma and biotech especially, seem like unloved industries right now, even though they are, in general, attractive for investors and trade at inexpensive valuations right now. Famed value investors like Buffett have realized that, and Berkshire Hathaway has been adding to some major names during Q3 and Q4, including Merck (MRK), AbbVie (ABBV), and Bristol-Myers Squibb. At 33 million shares, Berkshire now owns about $2 billion worth of Bristol-Myers Squibb's stock, making Berkshire one of the largest shareholders behind the ETF managers such as BlackRock (BLK).

Speaking about share ownership, let's quickly take a look at the alignment between shareholders and insiders. Insiders own about 6.4 million shares in total, worth about $400 million:

This is a quite sizeable amount of money in absolute terms, although insiders do represent less than half of a percentage point of all shareholders. This has to be expected for a company with a large market capitalization, though. Looking at recent insider activity, we see that there was a large number of options being executed, with a significant portion of the shares received being sold immediately after (but not on the open market).

The most recent direct sales occurred in November when three officers sold a combined 90,000 shares on the open market. This coincided with a price spike between October and November. I personally wouldn't read too much into those sales, which equate to just around 1% of total shares held by insiders, but it should nevertheless be noted that insiders haven't been as enthusiastic as Buffett & co.

There's A Lot To Like

The fact that Berkshire decided to up its stake in Bristol-Myers Squibb in Q4 can likely be explained by the reasons that make the company look attractive right now. This includes a strong performance in recent quarters, despite the pandemic:

Source: BMY presentation

Looking at the above slide, we see an array of positives. First, the company continued to generate attractive growth, despite the pandemic, as revenues rose by 10% year over year on a pro-forma basis. Reported revenues grew even faster (by 39%), but those were impacted by the Celgene takeover, which is why the 10% pro-forma revenue growth rate is more telling when it comes to evaluating the company's underlying business growth.

The company also made progress when it comes to launching new drugs, or launching existing drugs for new indications. This includes the launch of the Opdivo/Yervoy combo in first-line lung cancer, which is one of the biggest indications in oncology overall. It can be expected that the launch of the combination will allow Bristol-Myers Squibb to gain some market share in the coming quarters, which should have a positive impact on the company's revenue growth outlook.

Opdivo also got approved for first-line advanced renal cell carcinoma in combination with cabozantinib very recently, as the combination doubled progressive-free survival versus Pfizer's (PFE) sunitinib during the CheckMate-9ER study. The approval should improve Bristol-Myers Squibb's market share in the renal cell carcinoma market further, which is worth around $6 billion and growing steadily.

These treatment launches and new approvals should result in ongoing growth for Bristol-Myers Squibb's oncology portfolio, which is one of the largest among major pharma and biotech companies already.

The company is not only doing well in terms of bringing new drugs to the market, however, as Bristol-Myers Squibb also operates with strong financials. The recently-updated earnings per share guidance for 2021 calls for EPS of $7.45 this year, which equates to an increase of 16% versus the EPS of $6.44 that the company generated in 2020. Based on management's guidance, shares are trading for just 8.5 times this year's profits right now.

Bristol-Myers Squibb took on a sizeable amount of debt to finance the Celgene takeover, but since its balance sheet had been in pristine condition prior to the acquisition, the balance sheet looks still very healthy right now. According to the most recent 10-K, Bristol-Myers Squibb's net debt totaled $34 billion, based on $16 billion in cash and equivalents and $50 billion in short-term and long-term debt. Based on forecasted EBITDA of $25 billion for the current year (per YCharts), the company's leverage ratio is just 1.36, which is very low for a company that is recession-resilient and that has very low cash investment needs.

Bristol-Myers Squibb has decided to reduce its debt further, despite the fact that its leverage is not high, which shouldn't be too hard as the company expects to generate free cash flows of $45 billion to $50 billion between 2021 and 2023, i.e. about $16 billion a year. Since just ~$4.5 billion a year is needed to finance the dividend, Bristol-Myers Squibb could theoretically pay down more than $10 billion per year in debt if management focuses on that exclusively.

It is, however, likely that the company will make at least some minor takeovers, and the company will also engage in buybacks, which makes sense, as the return on that is significantly higher compared to paying down quite inexpensive debt. For 2021, management expects buybacks of around $3.5 billion, which should leave about $7-8 billion for debt reduction this year alone. If this is done, Bristol-Myers Squibb would enter 2022 with a net debt to EBITDA ratio of ~1.0.

The Long-Term Outlook

Some readers may be worried about the coming losses of exclusivity of some of Bristol-Myers Squibb's drugs, including Revlimid, the company's top seller. This is indeed a headwind, but not an issue that dooms the company at all. In fact, management expects that the company will be able to generate higher revenues in 2025 compared to now, despite the LOEs that will cut into its revenues over the years. This can be explained by the fact that approvals of new drugs and new indications for existing drugs will more than offset the headwinds that will stem from competition for some of its drugs.

Management is forecasting a compound annual revenue growth rate in the low-to-mid single digits through 2025. Calculating with the lower end of that range to be conservative, Bristol-Myers Squibb's revenues in 2025 should total around $47 billion. Management is also forecasting that its operating margin will be in the low-to-mid 40s in 2025, which suggests operating profits of ~$20 billion in 2025 - at the lower end of the guidance range.

Analysts are currently forecasting long-term EPS growth of ~7% a year, per YCharts, which indicates that investors could generate annual returns of ~10% a year when the dividend contribution is accounted for. If the valuation expands, actual returns could be way higher, however.

Takeaway

Buffett is not free of mistakes, but looking at the things he buys can still be a good idea. We agree that some big pharma and biotech names are undervalued and looking attractive right now, including Bristol-Myers Squibb.

Investors get a recession-resilient company with a solid long-term outlook trading for less than 9 times this year's earnings right now. Factoring in the dividend yielding a little more than 3%, this sounds like a solid deal for a sleep-well-at-night position that should provide solid returns over the coming years.

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