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Growth Ignored

|Includes: BMY, LLY, MRK, PFE, Sanofi (SNY)


                Sanofi trades at incredible metrics.  For a company that just posted a 6% EPS improvement and a 6% revenue increase based on a constant currency rate—the ratio’s the market has priced seems too good to be true.  The market implies the company is going nowhere—that growth and profitability exhibited are worthless. 

                Sanofi currently trades at 2011 p/ebitda of 3.26x. p/op earnings of 4.76x, p/fcf of 4.37x and has a fcf yield of 22.9%.  SNY has a 2011 gross margin of 74.5%, an operating margin of 36.1% and an ebitda margin of 52.6%.  SNY has a return on invested capital averaging greater than 45%.  By all metrics the fair value should be north of 120 billion.  It’s market cap is currently 75 billion. 

                Coming at it from a different angle, using an average wacc of 9.7%, an average terminal value of 6x with a 4.5% growth rate, it’s easy to see how Sanofi could be valued higher than 180 billion. 

                Telecom companies with higher capital investment rates trade at higher multiples than Sanofi—and that industry is nowhere near as profitable or economically valuable. 


                The market universally has been discrediting big pharma based on global fears stemming from generic competition.  In no other time has there been such generic competition—especially the competition starting roughly 2012. 

                Sanofi faces generic massacre of Plavix and Lovenox.  Tangentially Pfizer is losing Lipitor.  Merck, Lilly, and Bristol all face comparable losses.  The market is ready to throw them all out to the shed and forget them.  How else would a company with an operating margin of 36% trade at 3.26x ebitda and have a 22.9% fcf yield. 

                Is it justified?

                In most cases it is.  The pipelines of most big pharma are lacking.  To supplement dismal progress they have used large cash reserves to buy feasible future growth.  Pfizer reminds me of a bio tech mutual fund throwing blind folded darts. 

                But in the case of Sanofi, there is more than enough exposure to growth offsetting pending patent expirations.  For the last few quarters growth in vaccines has been strong via A/H1N1 sales.  Also, the emerging market division has been stepping up to the plate coupled with the Diabetes division cranking out double digit revenue growth—Lantus, Apidra and Amaryl are all firing on full cylinders. 

                Additionally, Sanofi is run more like a consumer staples stock like General Mills than a big pharma stock.  SGA margins are one of the best in the business and they have future plans to further reduce expenses by 2.8 billion by 2013.  That would be a 134 basis point improvement. 

                There is no reason for such dire multiples.  I can only come up with a few possible anchors.

1.        The proposed Genzyme transaction may not add any value.  In all metrics Genzyme is a slightly less profitable company—and the synergistic may not add up too much.

2.       Future growth may not be enough to offset patent erosion.

3.       The yearly capital management is poor.  DSO turns are north of 71 days, DIO turns are a scary 200 plus days and payables turn every 115 days. 


Capital management might alone be cause for Sanofi to be put in a dark closest, but the whole industry operates this way.  It’s not like Merck or Pfizer have better capital conversion cycles.

Based on everything else, I’m long Sanofi.


Disclosure: Long SNY, Long MRK, Short PFE