Gilead, Johnson & Johnson or Roche?

Everyone, including the pharmaceutical industry, has been hit hard recently in the political and the financial environments.

First, revenue:

Johnson & Johnson (JNJ, Financial), Roche Holding (RO, Financial) and Pfizer (PFE, Financial) are definitely bigger and probably could be labeled as "Big Earners" when compared to the latter pharmaceutical companies.

(I may have skipped some other favorites, such as Regeneron [REGN], Merck [MRK] and Bristol-Myers Squibb [BMY], but I had considered and decided to only include these companies for this article’s discussion.)

Next, profit growth:

Altogether, this selected pharmaceutical group has good performance over the past decade. A couple of off-the-roof growth here and there, but one worth noticing was Gilead’s (GILD, Financial) sudden upshot growth and Pfizer’s and Abbvie’s (ABBV, Financial) 50% profit loss.

Briefly, let me highlight these three companies (Gilead, Abbvie and Pfizer):

1. Gilead’s sudden explosion in 2014 profit growth was a result of 999% growth in Harvoni/Sovaldi sales. In 2013, Gilead received an approval of a game-changing drug called Harvoni, a mix of Sovaldi and Ledipasvir, to address HCV.
2. Abbvie’s poor profit growth was secondary to a breakup fee of $1.64 billion it had to pay to Shire PLC (SHPG) and other charges mentioned on page 31 of Abbvie’s 10-K. The Obama administration had deterred the merger and obviously did not want Abbvie to have a tax-lowering inversion deal moving forward.
3. Pfizer had an awful profit growth in 2014 due to the following:

• Loss of exclusivity and subsequent multisource generic competition for Celebrex in the U.S.
• The expiration of the co-promotion term of the collaboration agreement for Enbrel in the U.S. and Canada.
• The termination of the Spiriva collaboration in certain countries as well as by other product losses of exclusivity in certain markets.

Currently (recent 2015 Q4 Earnings announcement; last week of January to early February):

• Gilead had 50% profit growth on annual basis comparison (2015 to 2014). Harvoni drug sales grew by 59% (from Q4 2014 to Q4 2015).

• Abbvie had outstanding profit growth of 59% (annual basis). Reviewing it from GuruFocus’ 15-year financial data, Abbvie was actually growing from that loss in profits in Q4 2014. This explains the exemplary high growth. Nevertheless, Abbvie has 1.03% profit growth in the past six years. Further, here’s a chart:

Abbvie, nevertheless, has one blockbuster drug. This drug is Humira. It contributed 63% in its 2014 sales.

Humira was approved by the FDA in 2002. Its use is for treatment of arthritis, plaque psoriasis, ankylosing spondylitis, Crohn's disease and ulcerative colitis (source Micromedex). Nevertheless, Abbvie has over 250 patents protecting its mighty Humira in having any similar drug or biosimilar produce by the competitors.

• Pfizer, on the other hand, had another disappointing profit growth. The company reported 50% profit loss (from Q4 2014 to Q4 2015). The following are some reasons why Pfizer had "again" made this negative growth:

Loss of exclusivity and associated generic competition for the following:

• Celebrex in the U.S. and certain other developed markets.
• Lyrica in certain developed Europe markets.
• Zyvox in the U.S.

Next, let us see now how much revenue these companies are putting to R&D for drug development. I only see two ways for a pharma company to continue growing its sales; one is through acquisition, and the other is through research (or partnerships with other pharma companies).

R&D as per revenue:

Peer average is somewhere in the 20s. So on average, most companies would invest 20% of their sales in research. Celgene (CELG, Financial) (violet) definitely has its eyes set on producing more drugs from research. Abbvie and Pfizer also have been on an uptrend since 2013.

I observed Gilead and Biogen (BIIB, Financial) have declining allocation in research looking at the 10-year data. Johnson & Johnson appears to be stuck in the 11% to 13% range.

This chart can be a little deceptive, too.

For example, Johnson & Johnson definitely earns more than Celgene given its diversified revenue generators. In this case, here is how it looks in the chart for the two companies when looking at exact dollar terms:

Johnson & Johnson, I assume, has more firepower in research when compared to Celgene. One observation that can be derived from the R&D chart is that there are pharma companies that will follow their budgets strictly year in and year out and still produce good and stable profit growth, while others are determined to spend more on research in hopes of discovering their next "breakthrough" drug.

Further, not to discount the successes of Celgene in its Revlimid for the past decade (approved by the FDA in 2005), Revlimid also represents a big part of Celgene’s sales according to its latest annual report:

My best guess is that Celgene’s management is not ready to rest in just one or two (including Abraxane) major drugs for its sales and profit growth just yet.

Next, acquisitions in millions:

One can observe that these companies tend to acquire other companies more than average in different years. However, Pfizer is on a different level when compared to the rest.

To better understand the figures, here is a summation of dollars spent in acquisitions for each company mentioned in the past decade:

Next, debt-to-equity ratio:

Speculatively, I was expecting Pfizer to have ramped up its debt because of its acquisitions. However, Pfizer appears to have a conservative D/E ratio –Â even for the past decade.

These are the companies who have been increasing their debt in recent years.

Owner’s earnings (free cash flow) in millions:

"Big Earners" (Johnson & Johnson, Roche Holding and Pfizer) definitely are richer and more capable of providing shareholder return through their billions of free cash flow. One can also assume that this group has had steady growth over the years.

Next, the "Big Growers," Abbvie, Amgen (AMGN, Financial), Biogen, Celgene and Gilead:

Observations:

• Amgen has been consistent with its free cash flow over the past decade with 8.48% nine-year CAGR.
• Gilead = remarkable growth.
• Abbvie had been a performer but dropped in 2014 and 2015.
• Biogen and Celgene have been performing steadily but not as much cash compared to the previously mentioned companies.

Eventually, I came up with two groups (again) just by looking at their cash flow. I imagine if I had to select one from each group I would end up with Gilead, for the "Big Growers," and Roche Holding, for the "Big Earners."

Although Celgene has been an outstanding FCF growth machine, I don’t see any company that can grow 60% of its cash flow indefinitely.

Computed annual growth rate (CAGR)

*Abbvie’s data only started in 2009.

Ten-year average growth

Valuations (P/E)

Dividend yield

In summary, Gilead seems to be pretty much undervalued right now. I do suggest further dissection of the company’s fundamentals prior to purchase. On the other hand, Roche Holding is listed as an ADR and is based in Basel, Switzerland. This made me think of possible tax advantages/disadvantages, but that is beyond the discussion in this article.

Disclosure: I am long Johnson & Johnson and Pfizer, but I have no plans to purchase or add any shares of any pharmaceutical company in the next 24 hours.

Happy investing.

Mark