Published Jan. 28 by The Financial Canadian
For quality companies, declining stock prices are a benefit for investors. It allows for the purchase of more stock at a discount price. This is a sentiment that is shared by many of the world’s most successful investors.
“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
– Warren Buffett
One stock that fits this bill right now is Bristol-Meyers Squibb (BMY, Financial). Since July, the company’s stock has decreased in value by 39%.
Source: Yahoo! Finance
This article will discuss the investment prospects of Bristol-Meyers in detail.
Business overview
Bristol-Meyers Squibb is a global pharmaceutical company headquartered in New York City. The company was formed by the merger of the Squibb Corporation and Bristol, Meyers, & Co. in 1989.
The company manufactures medicine that helps millions of patients combat diseases like hepatitis B, hepatitis C, HIV/AIDs, rheumatoid arthritis and cardiovascular disease.
Bristol-Meyers Squibb has a well-diversified product base with seven products with more than $1 billion in sales, listed below:
- Opdivo: $3.77 billion of 2016 sales.
- Orencia: $2.27 billion.
- Sprycal: $1.82 billion.
- Hepatitis C Franchise: $1.58 billion.
- Baraclude: $1.19 billion.
- Sustina Franchise: $1.07 billion.
- Yervoy: $1.05 billion.
This diversity in BMY’s product lineup will be a key insulator from the risks that are driving the company’s stock price lower and will be discussed in more detail later in this article.
Current events
On Jan. 27, Bristol-Meyers Squibb reported fourth-quarter and full-year results for fiscal 2016.
Financial results were robust. The company saw 22% (24% in constant currency) increase in quarterly sales and for the full-year, revenues increased by 17%.
In this earnings report, BMY confirmed its earnings guidance for fiscal 2017. Management expects 2017 GAAP EPS in the range of $2.46 to $2.67, which aligns with previous guidance. The company also reduced non-GAAP EPS guidance to $2.70 to $2.90 from previous guidance of $2.85 to $3.05.
Bristol-Meyers Squibb also reported two key milestones for its flagship drug Opdivo. Most important is the U.S. approval for Opdivo’s treatment of metastatic squamous cell carcinoma of the head and neck. The drug was also approved in Europe for the treatment of Hodgkin’s lymphoma.
The company’s stock price has seriously declined in recent months. The main driving force behind the decline of BMY’s stock was also related to Opdivo.
While the drug made significant regulatory progress, it failed to show promise in combating advanced non-small cell lung cancer (NSCLC).
The drug was expected to show strong clinical trial results in this highly lucrative area, which was expected to result in market dominance for BMY. It was estimated that long-term annual sales from Opdivo could grow to $4 billion in the U.S. alone.
Instead, this industry is being taken over by a key competitor. Merck’s (MRK, Financial) Keytruda has performed well in recent clinical trials and is rapidly growing market share in the treatment of NSCLC.
Although Opdivo’s results are disappointing, I believe the market has overreacted on BMY’s stock. Bristol-Meyers Squibb is not a one-trick pony. The company has many other flagship drugs with significant sales potential, including the other six $1 billion drugs I listed above.
There are also possibilities to combine Opdivo with Yervoy, another drug produced by BMY, to treat other diseases. This will be a contributor to future Opdivo sales and the company’s top line as a whole.
There are also three promising drugs in BMY’s pipeline: Empliciti for treating multiple myeloma; Prostvac, a vaccine for prostate cancer; and Daclatasvir, a treatment for hepatitis. Each of these drugs are expected to provide significant boosts to BMY’s sales in the future.
Right now, it appears as though the market is overreacting to the Opdivo news. I believe that Goldman Sachs had the right idea in a recent announcement, saying “Bristol’s current price reflects no value for Opdivo in lung cancer and any weakness represents a buying opportunity.”
Growth prospects
Historically, BMY’s growth has been erratic but strong over the long run. GAAP EPS growth from 81 cents in 2006 to $2.65 in 2016 represents a CAGR of 12.6%.
Source: Value Line
In the long run, I believe that investors can reasonably expect long-term EPS growth in the range of 6% to 8%.
The company has paired this earnings growth with solid dividend growth. While the company is certainly not a Dividend Aristocrat, they have raised their annual dividend every year since 2009, making seven consecutive years of dividend increases.
This puts the company on pace to become a Dividend Achiever in 2019. The Dividend Achievers are strong businesses with 10-plus years of consecutive dividend increases.
Source: Value Line
Looking ahead, the main driver of growth for Bristol-Meyers Squibb is the company’s robust drug pipeline. It will also benefit from the continued growth in the existing portfolio of drugs.
For example, BMY saw fantastic growth in the sales of its drugs Eliquis and Orencia in fiscal 2016. Revenues increased by 58% and 16%, respectively.
Competitive advantage and recession performance
As a pharmaceutical company, the competitive advantage of Bristol-Meyers Squibb largely comes from its product portfolio. The company’s drugs are the source of its competitive advantage.
This is not as strong of a competitive advantage as is present in some other industries. There are relatively low barriers to entry in the pharmaceutical industry. New research and drug developments can quickly erode the popularity of drugs that generate sales for a company like Bristol-Meyers Squibb.
That being said, the company performed well during the global financial crisis of 2008 to 2009. Consider its per-share earnings during that period:
- 2007: $1.09.
- 2008: $1.59 (45.9% increase).
- 2009: $1.63 (2.5% increase).
- 2010: $1.79 (9.8% increase).
As you can see, Bristol-Meyers Squibb did not experience a single year of negative earnings growth during the financial crisis.
One reason why is that the financial results of large pharmaceutical companies are somewhat insulated from larger economic trends. Earnings are driven by product innovation more so than traditional levers like supply and demand.
This was witnessed in the years following the financial crisis. Consider BMY’s EPS during the period 2011 to 2014.
- 2011: $2.16.
- 2012: $1.16 (46.3% decrease).
- 2013: $1.54 (32.8% increase).
- 2014: $1.20 (22.1% decrease).
This level of earnings volatility is very undesirable for investors. This should be considered before purchasing shares of BMY.
Valuation and expected returns
Bristol-Meyers closed at $46.82 on Jan. 26. Based on the recently announced 2016 GAAP EPS of $2.65, it is trading at 17.7 times earnings. If we are to consider non-GAAP earnings instead, the company reported $2.83 of adjusted diluted EPS, which corresponds to a 16.5 times valuation multiples.
The following diagram outlines how this compares to the company’s historical valuation multiples.
Source: Value Line
Bristol-Meyers Squibb is trading at valuation multiples not seen since 2011. This has been caused by both earnings growth and the company’s recent drop in stock price.
Further, the company trades at a significant discount to the general stock market. The S&P 500 trades at a price-to-earnings ratio of 25.8, which makes BMY’s valuation look even more attractive.
To conclude, there is a high probability that valuation expansions will be a contributor for returns for BMY shareholders.
Long-term total returns will be composed of:
- 3.2% dividend yield.
- 6% to 8% earnings growth.
This gives a base-case of 9.2% to 11.2% total returns for BMY investors. These returns will likely be boosted by valuation expansions, and could also be affected (positively or negatively) by further developments regarding Odipvo.
Final thoughts
Without a doubt, Opdivo represents a large proportion of BMY’s future growth prospects. The drug’s sales were $3.77 billion in fiscal 2016 on $19.43 billion of total revenues, meaning Opdivo contributed nearly 20% to the company’s top line.
All else being equal, if this drug were completely eliminated from the company’s product lineup, the stock price could be expected to drop by roughly 20% as well. Instead, the price has declined by 39%, or roughly twice the amount I would expect if the drug’s sales were eliminated completely.
Based on this, I believe the stock’s price decline presents a buying opportunity rather than a reason to avoid this stock.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
– Warren Buffett (Trades, Portfolio)
It is very difficult to have the discipline required to purchase companies when they’re "on the operating table."
However, Bristol-Meyers Squibb is a buy for investors who understand the health care industry and the risks associated with the current state of Opdivo.
Disclosure: I am not long any of the stocks mentioned in this article.
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