Bristol-Myers: Don't Let This One Get Away

Bristol-Myers Squibb Co (BMY, Financial) is an 80-year-old biopharmaceutical company. Operating in one segment alone, it is engaged in the discovery, development, licensing, manufacturing, marketing distribution and sales of biopharmaceutical products. These include chemically-synthesized drugs, or small molecules, as well as an increasing portion of products produced from biological processes, which typically involve recombinant DNA technology, called ‘biologics’.

Bristol Myer’s revenues come from products in the following therapeutic classes: cardiovascular, virology, oncology, neuroscience, immunoscience and metabolics. Last quarter the company reported a net sales increase of 9 percent to $4.1 billion mostly driven by strong sales of drugs targeting the oncology and diabetes markets. And although it has very strong returns on capital (42.40 percent, more than two times higher than the industry median) some investors have chosen to reduce their stakes in this company, such as Jean-Marie Eveillard (Trades, Portfolio), Irving Kahn (Trades, Portfolio) and Steve Cohen. But if this business is strong and isn’t losing any money, why is that?

Dissolving economic moat?

The company will be plagued by 2016 with major patent losses which are expected to create a drag on overall growth and, as generic competition looms large over Bristol-Myers, this firm’s pipeline needs to start delivering soon. However, the company has had a number of pipeline and regulatory setbacks in the last few quarters. In 2012, Brivanib –a drug for hepatocellular cancer- performed disappointingly in a phase III study and it voluntarily suspended a phase II study evaluating a hepatitis-C drug candidate, after a patient’s heart failure and death during trial.

Last September, the company announced disappointing data from a phase III study on skin-cancer drug Yervoy in previously-treated castration-resistant prostate cancer patients, which revealed that the treatment with the drug failed to prolong overall survival in patients compared to placebo. Subsequently, doubts have been raised as a large portion of Bristol’s current valuations is considered to be tied to cancer drug Nivolum, which could also have an amplified negative impact on the stock if clinical data are poor as well.

Recently, the company has reached an agreement to end the diabetes joint venture that it had with AstraZeneca (AZN, Financial), with this company buying out Bristol-Myers’ stake as the company announced it will stop its research and development activity in diabetes, hepatitis C and neuroscience after another disappointing run with multiple drugs and rising FDA demands for new drugs.

Furthermore, the Bristol carries a high price to earnings multiple in comparison to the industry median, even despite the company’s significant patent losses, which seems to be the main discouraging reason for many to buy this stock.

A Bet for the Long Run

Although Bristol-Myers is currently available at a price premium and has not generated a robust dividend growth, over the past five years the company has incrementally increased its dividend by a penny per annum. Now, with Bristol poised for secular growth and declining R&D needs, the company is expected to accelerate dividend growth over the next three years.

Also, the company has been trying to offset the declining sales of some of its most prominent products as well as combating the generic threat over its key drugs. It has not spared on efforts to develop its already robust pipeline and has brought in new products through in-licensing and partnering deals and acquisitions, thereby driving its top line. Over half of Bristol’s late stage pipeline focuses on immunology and cancer, both indications where the FDA aggressively approves drugs —Â which also carry strong pricing power. In this segment, Nivolumb’s early stage results were outstanding and, now in a late stage, it has the potential to radically shift the treatment paradigm in several cancer indications, and to open the door to the $20 billion market and result in peak sales of more than $5 billion annually.

Although Bristol-Myers’ economic moat is facing some headwinds, based on the company’s entrenched sales force and broad lineup of patent protected drugs, it can be said that it still is wide. Also, several of its marketed drugs are biologic, as mentioned earlier, which creates additional impediments for generic firms to produce their drugs as the cost of developing and marketing biosimilars is much higher than for typical generic small molecules.

To sum up, in 2016 when the company passes the majority of patent losses and pipeline products begin to launch, Bristol growth prospects will then increase significantly. So seem to think some gurus like Paul Tudor Jones (Trades, Portfolio), Steven Cohen (Trades, Portfolio) and even the Vanguard Health Care Fund (Trades, Portfolio), who have increased their portfolios' stake on this company. To them, the stock is worth the price premium it carries (at least, for a long-term investment).

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Disclosure: Damian Illia holds no position in any stocks mentioned.