Shares of Bristol-Myers Squibb Co. (BMY, Financial) are up roughly 5% since I thought that the stock deserved better than a single-digit price-earnings ratio. I thought previously that Bristol-Myers might have the potential to return better than 50% just with the price-earnings ratio trading within a range closer to that of peers.
Following second-quarter results, that thesis remains in place.
Second-quarter highlights
Bristol-Myers reported second-quarter earnings results on Aug. 6. Revenue increased 62% to $10.1 billion, which was $89 million above what Wall Street analysts had expected. Adjusted earnings per share improved 45 cents, or 38%, to $1.63. This was 15 cents better than expected.
Excluding the Celgene acquisition, revenues were flat. Covid-19 reduced results by approximately $600 million, which mostly offset a benefit from the ongoing pandemic in the first quarter. Inventories were built up during the first quarter in anticipation of higher sales prior to stay-at-home directives being issued.
U.S. sales were higher by 77% to $6.5 billion while international sales increased 40% to $3.6 billion.
Revlimid, which treats myeloma in combination with other medications and anemia, grew 6% to $2.9 billion. The drug benefited from longer durations of use and higher utilization as a front-line treatment. Revlimid does lose patent protection starting in 2022.
Eliquis sales improved 6% to $2.2 billion. Eliquis, which is used to prevent blood clots, saw higher demand in the U.S. Growth was slowed from the first quarter, where the drug had 37% growth, due to destocking. It was announced in August that a U.S. District Court upheld patents for both composition of matter, which expires in 2026, and formulation, which expires in 2031. Eliquis should eclipse at least $10 billion in sales in 2020.
Opdivo, which treats several different cancers, saw sales fall 9% to $1.7 billion. Part of this decline was attributed to fewer patient starts as a result of the pandemic, but Opdivo could also be losing ground to Merck & Co.'s (MRK, Financial) Keytruda in the area of non-small cell lung cancer. That may be changing as Opdivo, in combination with Yervoy, was approved by the Food and Drug Administration for first-line treatment in non-small cell lung cancer at the end of May. This combination also received approval as a first-line treatment for the same cancer in Canada on Aug. 11.
Among Bristol-Myers smaller drugs, Pomalyst sales grew 21% to $900 million. This drug is taken in combination with Revlimid to treat blood cancer. Increased treatment duration was a prime reason for the growth. Year-to-date sales for Pomalyst are higher by 25% to $1.5 billion, making the drug the company's fifth-best-selling drug.
The company also gave some updates on product approvals and recent launches. Bristol-Myers expects several approvals for various drugs over the next year, including two for Opdivo. The company recently launched Reblozyl, which treats anemia. It added $55 million in second-quarter sales, but could reach $2 billion of annual sales. Reblozyl is already seeing solid early adoption rates and majority of initiated patients have received a second dosing.
Sales for the company's multiple sclerosis drug Zeposia added just $1 million in sales, but might generate as much as $5 billion in peak sales. Zeposia, which was added to the portfolio by way of the Celgene purchase, is already recognized as a best-in-class drug and has experienced a breadth of initiation across providers.
Inrebic generated just $15 million of sales in the quarter, but could achieve $400 million in annual sales. Inrebic was approved for first line or follow-up treatment for myelofibrosis and was also part of the reason Bristol-Myers purchased Celgene.
In total, Bristol-Myers believes that new launches could add approximately $20 billion in annual revenue in the second half of this decade. This doesn't include the 20 or so other products that the company expects to bring to market over the next three years.
Back to the quarter, gross margins increased 480 basis points to 73.4% as inventory destocking was more than offset by better product mix. Selling, general and administrative expenses were up 51% to $1.6 billion, but that was due almost entirely to the acquisition of Celgene. For similar reasons, research and development grew 90% to $2.5 billion.
Dividends distributed was slightly more than $1 billion, which is $350 more than the second quarter of 2019. The increase in dividends is due in large part to the issuance of shares to fund the buying of Celgene. At the same time, free cash flow was up almost 119% to $4.1 billion. The payout ratio was just over 24%, which compares very favorable to the average payout ratio of almost 60% over the previous four years.
Adding Celgene brought an incredible amount of cash flow to Bristol-Myers. Total free cash flow for the first half of 2020 is $7.9 billion, compared to $3.1 billion over the same period of time in 2019. Putting this into a greater context, free cash flow through the end of June 2020 is $700 million more than free cash flow for all of 2019.
Valuation analysis
Bristol-Myers reaffirmed its earnings per share guidance for 2020, with an expected range of $6 to $6.20. Analysts believe, according to Yahoo, that the company will produce $6.27.
Using the current share price of $62.67 and the midpoint of the company's earnings guidance, shares have a forward price-earnings ratio of 10.3.
As I said previously, Bristol-Myers' valuation has varied widely over the last decade with an earnings multiple as low as 13 and a high of more than 43.
As before, let's compare Bristol-Myers forward price-earnings ratio to its peers:
- AstraZeneca PLC (AZN, Financial): 28.9
- Eli Lilly & Co. (LLY, Financial): 20.8
- Merck & Co.: 15.0
- Novartis AG (NVS, Financial): 15.1
- Pfizer Inc. (PFE, Financial): 13.0
- Sanofi (SNY, Financial): 15.0
Bristol-Myers continues to trade with a valuation that is significantly below its peer group. This says to me that the market doesn't believe the company's product portfolio isn't as attractive as other names in this sector.
Revlimid losing patent protection in two years is a concern, but the company expects strong growth rates for newly launched products in addition to many new launches expected in the coming years. Of course, there are always pitfalls when it comes to drug approval, but Bristol-Myers has several drugs that appear promising.
Given the strength of current business, the acquisition of Celgene and the balance sheet, a price-earnings range of 13 to 15 seems appropriate. This would take into account headwinds such as Revlimid's patent loss, but would more fully value Bristol-Myers in my opinion.
Using earnings per share estimates and my valuation range, my price target range remains $72 to $92. This would be a 26% to 47% increase in share price. This would be in addition to the dividend yield.
The yield would be 2.5% at the low end of my price target range and 2% at the high end. Therefore, total returns could be 28.5% to 49%.
Final thoughts
Bristol-Myers has seen a mid-single-digit return since the end of May, but I believe the stock has a considerable way to go to being fairly valued. The company's purchase of Celgene has added greatly to sales and free cash flow. Celgene has also added several promising drugs to the company's portfolio.
While the company's top-selling drug does face generic pressure in a few years, the market doesn't appear to believe that the company's pipeline is enough to make up for this. This is likely why the stock has such a low valuation compared to peers.
I believe this is a mistake. Bristol-Myers' pipeline looks good and should help to offset the loss of exclusivity of drugs like Revlimid and eventually Eliquis.
Because of the company's product portfolio, pipeline and valuation, Bristol-Myers looks like an extremely undervalued stock today, making it a strong candidate for purchase.
Disclosure: The author has a long position in Pfizer.
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