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Sanofi Continues to Struggle on Its Path to Recovery

November 23, 2013 | About:

One of the world’s leading pharmaceutical companies, Sanofi (SNY), has recently received a setback when the U.S. regulators raised serious questions over one of its new drugs. This was a small addition to Sanofi’s long list of woes. The firm has reported declining profits for five consecutive quarters. In its most recent quarterly results, the company missed both top and bottom line estimates. Like some of the other pharmaceutical giants, Sanofi has struggled with growth following the loss of patents on some of its blockbuster drugs, such as Plavix. The business has failed to come up with newer drugs that could offset the losses coming from patent expiration. Therefore, it wasn’t surprising when Warren Buffet’s Berkshire Hathaway (BRK.A)(BRK.B) decided to sell the shares of Sanofi and its European peer GlaxoSmithKline (GSK).

Question Marks over Lamtrada
Sanofi has been working on the development of its multiple sclerosis treatment drug, Lamtrada. The drug became a part of Sanofi’s pipeline when it acquired the biotech firm Genzyme for $20 billion last year. The dryg’s future prospects played an important part in the determination of Genzyme’s price tag. However, its efforts received a serious setback when earlier this month, the U.S. regulators raised serious concerns saying that the drug has "serious and potentially fatal safety issues." Drug still has some chances of approval if it is proved that it delivers substantial benefits to patients that outweigh the risks. The final decision will be taken by the end of the year.

On the other hand, the drug has already received the approval from European regulators and will be available in Europe in the near future. Analysts believe that Lamtrada can generate annual global sales of $752 million by 2018.

Five Consecutive Quarterly Drops
In the third quarter of 2013, Sanofi’s revenues dropped by 6.7% from last year to $11.30 billion while its net income dropped by 18.7% in the corresponding period to $2.40 billion. This translated into a 19.2% drop in earnings per share to $1.81. On other hand analysts were expecting earnings of $1.92 per share from revenues of $11.48 billion. To make matters worse, Sanofi also had operational problems in Toronto and Brazil. Besides, the currency fluctuations also hit its bottom line by more than 10%.

Earlier this year, when Sanofi released its annual results for 2012, the management said that they are expecting an of the patent cliff in 2013 and a turnaround from H2-2013. In the previous quarter, Sanofi finally confirmed that the patent cliff period has come to an end and as evidence, the firm pointed out that on constant currency basis, its revenues have actually grown by 0.6% from the same quarter last year.

Sanofi reported a 5.5% increase in quarterly sales of its Growth Platform to $8.46 billion, on the constant exchange basis. Here, the diabetes drug Lantus was the top performer that fetched $1.9 billion in net sales, showing an increase of more than 20% from last year, on constant currency basis.

Diabetes has clearly become an integral part of Sanofi but in this segment, Sanofi faces tough competition from the world’s biggest Insulin maker Novo Nordisk (NVO). Unlike its European peer Sanofi, in its recent quarterly results, the Denmark based Novo Nordisk reported a 13% increase in profits. However, the company still missed the market’s estimates compiled by Bloomberg.

Problems in Key Emerging Markets
Sanofi gets 31.5% of its revenues from emerging markets, where its growth remained at around 2.8%. This less-than-impressive growth was due to the slowdown in the Chinese market and a decline of generic sales in Brazil.

In China, the economic slowdown, coupled with the government’s crackdown on the sales practices of pharmaceutical companies, has created a challenging business environment. The Chinese government started its investigation on some of the leading Pharmaceutical firms following the bribery allegations against GlaxoSmithKline.

Earlier in August, the company announced that some government officials have paid a visit to Sanofi’s office in China and have taken away some documents with them.

The negative effects of the probe were apparent in the quarterly results when Sanofi reported a growth of 5% in Chinese sales to $470 million, a significant drop from a growth of 15.3% for the quarter ending in June, before the bribery allegations surfaced.

Moreover, Sanofi continues to face problems with inventory in Brazil. In the previous quarter, the business reported a 17% drop in revenues in the country. The company has already lost hundreds of millions in Brazil due to the mismanagement of inventory by the management. Sanofi has responded with a significant overhaul of its operations in the country, which included several layoffs of some of its key employees in the region. However, with the management changes, Sanofi’s CEO Christopher Viehbacher believes that Brazil is “back on track.”

… and Developed Markets
Meanwhile, last year’s manufacturing problems related to Sanofi’s Toronto facility are still not over. The supply issue has created a shortage of some of the higher margin vaccines, such as Pentacel, Adacel and Daptacel. As a result, Sanofi has, once again, missed out from earning revenues that could have supported its struggling bottom line.

Conclusion
Sanofi’s current quarterly results were disappointing as the company continues to struggle due to the development of generic versions of some of its drugs. Meanwhile, operational problems in Brazil, Toronto and a slowdown in China have exacerbated the tough situation. As a result, Sanofi has lowered its (adjusted) earnings guidance from previous estimates and is now looking at a 10% drop in annual earnings.

However, the improvement in the adjusted net sales is a good sign. The problems in Brazil appear to have been resolved. The business is also expecting improvements from Toronto in the current quarter and the supply issues should be over by the end of Q1-2014. More importantly, the business believes that it has crossed the patent cliff and is now on a path to recovery.

Sanofi’’s shares have fallen by nearly 4% in the last 6 months but due to the continuous drop in profits, they are still trading more than 30 times their trailing earnings. Due to the unattractive valuation and a tough business environment, I do not believe that Sanofi is a buy; but its stock could rise in the coming months in anticipation of more numbers that could support its “recovery” story.

Notes:
Sanofi S.A. Q3 2013 Results PR [Pdf]
Novo Nordisk financial report for nine months ending September, 2013 [Pdf]
Sanofi Management Discusses Q3 2013 Results - Earnings Call Transcript
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


Rating: 2.8/5 (4 votes)

Comments

kfh227
Kfh227 premium member - 4 months ago
If FCF recovers slightly, it is fairly valued. If FCF can jump, it could be very well undervalued.
yakag
Yakag premium member - 4 months ago
Nice article. However, I believe you are overlooking the fact that cash flows are almost twice reported earnings. This is due to massive amortization charges from the Genzyme acquisition. If you leave those out, the company is trading at about 11X next year's cash flow. Hardly an expensive multiple for a differentiated pharma with exposure to high growth markets. Most of the issues you reported are temporary rather than structural in nature.

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