Interactive Investor

Stockwatch: results sell-off could be an opportunity

30th April 2021 09:13

Edmond Jackson from interactive investor

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Our stock picker is intrigued by this share’s relatively modest valuation and market forecasts.

Big tech stocks have seized attention this week for very strong underlying performance in the first quarter of 2021. Yet many share prices have responded lethargically, or even fallen, as if investors realise they are priced for years more of supernormal growth.  

Cheap valuation parameters, partly justified 

Pharmaceuticals have underperformed the market, so I was interested to check out results and outlook from Bristol-Myers Squibb (NYSE:BMY). This is a $147 billion (£105 billion) global pharmaceuticals group serving mainly the developed world: the US accounted for 63% of 2020 revenue, Europe 23% and rest-of-world 14%. 

At $62.70, its stock – if management guidance is fair – trades on a sub 9x prospective price/earnings (PE) and circa 3% yield. It has lagged the US market this year, up 8% compared with a 13% rise for the S&P 500 index.

It enjoys a strong free cash flow profile. Since 2015 it has grown at an annualised rate of over 46% versus an industry average of 16%. This has helped support investment, pay-outs and debt in pursuit of acquisitions to bolster the drugs portfolio.  

At end-March there was $33.4 billion net debt (down from $34.4 billion at end-2020), which needs to continue falling if the stock is to be seen as a hedge against growth stocks liable to drop if US interest rates have to rise to check inflation. 

Several drug patents also expire in the years ahead, opening them up to competition and margin pressure. Yet management is confident it can “more than overcome” sales deterioration in some products. 

Robust Q1 numbers, albeit key drug sales behind hopes  

Group first-quarter revenue is up 3% to $11.1 billion compared with analysts’ estimates for about 4% annual growth in each of the next five years. “Excluding Covid-19 related buying patterns” from the prior year period however, growth is 8%. It appears stocking in response to early signs of the pandemic during 2020 may have made for a tough comparator. The table of product revenue highlights does however average out at moderate single-figure growth.  

Recent US dollar weakness has also had an effect. While US revenues rose 4% to $7.0 billion, international revenues edged up just 1% to $4.1 billion but fell 5% after currency translation.

The gross margin has risen from 66% over 74%, albeit boosted by unwinding of stock acquired at lower prices, and on a non-GAAP basis the margin eased slightly to 78% due to currency. Like-for-like it would appear margins are stable and good. 

Sentiment towards pharmaceutical stocks does very often hinge on perception of key changes within the drugs portfolio. Quarterly reports confront you with a spread of drug titles (see table below) where a degree of variance is inevitable.  

From this release, the key upshot – why the stock has eased 5% – is lower-than-expected sales of cancer drugs Revlimid and Opdivo. The shortfall was partly mitigated by blood-thinner Eliquis coming in ahead of expectations; this being the world’s leading oral anti-coagulant whose 2020 sales rose 16% to $9.2 billion  
Margin contrasts within these dynamics also meant group earnings per share (EPS) came in at $1.74 - versus $1.72 a year ago, and recent consensus for $1.82. 

Market is sensitive about any change in Revlimid sales 

As an expensive oral treatment for myeloma cancer, Revlimid constituted over 28% of the group’s $42.5 billion revenue last year. Approved by the US Food and Drug Administration over a decade ago, it was part of Celgene Inc which Bristol-Myers Squibb acquired in November 2019. 

Revlimid has been achieving double-digit annual growth rates and struck 18% like-for-like in the fourth quarter of 2020, making this latest drop to 1% in the first quarter of 2021, look stark.  

It has been helped by more cancer screening and longer duration of use, albeit significantly by regulatory protection from competition until end-January 2026. A key question for investors is therefore whether emerging drugs can (more than) offset its downside risks thereafter. 

New drugs lend medium-term hopes for upside 

Zeposia (for multiple sclerosis) and Inrebic (anti-blood cancer) attract longer-term hopes from a current small base, and a leap for Reblozyl (anti-anaemia) shows how sales can take off. New drugs (not in the table) include Abecma, a multiple myeloma treatment approved by US regulators at end-March, and Breyanzi, anti-lymphoma cancer.  

Opdivo, the group’s number three drug in immunotherapy, has seen a 3% quarterly decline after sales eased to $7 billion last year, but is undergoing clinical trials as a mono or combination-therapy hence continues to offer growth prospects. 

Drugs groups can come across as a host of peculiar names which seem inherently speculative. If rated on a 20x PE, then you quite reasonably wonder “what margin of safety?”, but when the multiple is modest and earnings are well-backed by cash flow, a pipeline of new products can tilt the risk/reward profile positively. 

First quarter product revenue highlights ($ millions)
Product 31/03/2020 31/03/2021 % change
Revlimid 2,915 2,944 1%
Eliquis 2,641 2,886 9%
Opdivo 1,766 1,720 -3%
Orencia 714 758 6%
Pomalist/Imnovid 713 773 8%
Sprycel 521 470 -10%
Yervoy 396 456 15%
Abraxane 300 314 5%
Empliciti 97 85 -12%
Reblozyl 8 112 1300%
Inrebic 12 16 33%
Onureg N/A 15 N/A
Zeposia N/A 18 N/A

Source: Bristol-Myers Squibb

Mean reversion of equity values may still apply

Management continues to guide for annual EPS in a $7.35 to $7.55 range, implying a forward PE of 8.6x – a big contrast with 30x and more, applying to various growth stocks.  

If you respect “mean reversion” as a central tenet of value investing – that stock prices revert to their long-run average over time – then now would still be timely to consider a blue chip international pharmaceutical stock like this. I have also recently made the case for London-listed AstraZeneca (LSE:AZN)

Admittedly, the US stock market is pricey. Its healthcare sector currently trades on 16.7x earnings compared with a 10-year average of 15.0x, whereas information technology trades on 27.8x versus a 16.6x historic average. Industrials rate nearly as high as IT, while the S&P 500 overall is on a 22.5x forward PE versus a 15.9x average over 10 years.   

The likes of Bristol-Myers Squibb would not be immune to any market slide, but its downside should be limited – like it has already shown in March 2020, with a negligible drop. At the extreme end of the current valuation scale, Netflix (NASDAQ:NFLX) recently plunged 10% after subscriber uptake growth slowed.   

Chart context remains positive if yet to affirm “growth” 

In a long-term context, it appears more like a cyclical stock. Over the mid to late 1990’s there was a strong rally from $15 to $70, only for the stock to plunge to $25 after the 2000 market break and trade sideways for a decade.  

There was then another run over $71 by March 2016 and a drop back to $45 three years later. Rising expectations and underlying delivery has, however, sustained a modest rally to a mid-$60 area currently. 
The chart is therefore supportive, but nothing stretched in a macro context that only needs a modest element of portfolio re-positioning from exorbitantly-priced growth stocks, to benefit pharmaceuticals. 

While the current consensus view is central banks having succeeded to abolish the business cycle and sustain equity values, history suggests belief in “everlasting prosperity” reflects a euphoric phase, from which high-priced stocks eventually de-rate. 

On such a rationale I suggest Bristol-Myers Squibb as a candidate to consider averaging into. Buy.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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