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Bristol-Myers Squibb Company (BMY)

Bristol-Myers Squibb (BMY) traces its roots back to 1887 and is one of the world's largest biopharmaceutical businesses. The company offers drugs in the various therapeutic classes, such as oncology, cardiovascular, immunoscience, and virology, including human immunodeficiency virus (HIV) infection. 

Bristol-Myers' top 10 drugs account for 90% of sales and include the following major contributors: 

  • Opdivo (24% of 2017 sales), a biological product for the treatment of anti-cancer indications
  • Eliquis (24% of 2017 sales), an oral inhibitor targeted at stroke prevention in atrial fibrillation
  • Orencia (12% of 2017 sales), which treats adult patients with active rheumatoid arthritis
  • Sprycel (10% of 2017 sales), a tyrosine kinase inhibitor for the treatment of adults with Philadelphia chromosome-positive chronic myeloid leukemia 
  • Yervoy (6% of 2017 sales), a monoclonal antibody for the treatment of adults and pediatric patients with unresectable or metastatic melanoma
  • Baraclude (5% of 2017 sales), a selective inhibitor of the hepatitis B virus

While the company is highly diversified around the globe, the majority of its sales still come from the United States:

  • US: 55% of 2017 sales
  • Europe: 24% of 2017 sales
  • Japan: 7% of 2017 sales
  • Rest of the World: 14% of 2017 sales

Bristol-Myers sells products to wholesalers, retail pharmacies, hospitals, government entities, and doctors. The company has a research partnership with Sirenas, as well as a strategic development and commercialization collaboration agreement with Nektar Therapeutics. 

Business Analysis

Global drug sales are expected to grow by about 5% annually to reach $1.3 trillion by 2020, according to the International Trade Administration. Higher demand is expected to be driven by an aging population in developed countries, as well as strong population growth in emerging economies.

This huge and growing global market, combined with the recession-resistant nature of medication sales, makes some drug makers potentially attractive income growth investments.

In addition, the high research costs (up to $2-3 billion per drug), very long development times (usually 10 to 15 years), and 20-year patent protection afforded to new medications can create a very wide moat for drug makers and lead to extremely high margins.

The downside is that these factors also create very high volatility in sales, earnings, and cash flow, due to patent expirations and competition from rival drugs that target the same conditions via slightly different means. For example, Bristol-Myers' sales dropped 17%, 7%, and 3% in 2012, 2013, and 2014, respectively, during the patent cliff.

For investors who have a stomach for the inherent volatility of the pharmaceutical industry, a key to doing well is to invest in large blue-chip companies with sufficient resources, economies of scale, and strong drug portfolios to help stabilize and grow earnings over time.

Brystol-Myers could be one such drug maker, as the company's management team has shown a solid ability to navigate the challenging and fast-changing drug industry while making relatively smart capital allocation decisions.

For example, the company has sold off its non-pharmaceutical businesses, such as over-the-counter non-patented drugs, to focus exclusively on leading edge specialty medications. The company has also been one of the first movers into the realm of biological drugs, including antibody related cancer treatments via its 2009 acquisition of biotech company Medarex for $2.4 billion.

That acquisition helped boost Bristol-Myers' IP portfolio and give it an edge in biological drugs, which are both more effective than chemical-based medications, and also more profitable. In addition, unlike chemical-based drugs, when a biological drug goes off patent, generic competition takes longer to develop. That's because rather than copy the chemical formula directly (and thus avoid new drug trials), biological generics (called biosimilars) still require their own drug trials.

Brystol-Myers' increased focus on biological drugs with an emphasis on immuno-oncology has turned the company into a sales powerhouse thanks to blockbuster drugs such as atrial fibrillation medication Eliquis and cancer drug Opdivo, which combine to represent close to half of company-wide revenue and grew more than 30% in 2017. 
Source: Bristol-Myers Investor Presentation
Eliquis has 74% market share, up from 31% in 2014, thanks to its superior response rate compared to the current standard of care. Meanwhile, Opdivo is a PD L1 inhibitor, meaning that it blocks the ability of certain tumors to hide from the immune system.

Since 2014, Opdivo has received over 250 approvals to treat various tumors around the world and has become a driving force for Bristol-Myers' strong growth. In fact, Brystol-Myers has become an industry leader in immuno-oncology, meaning the treatment of cancer that uses the body's own defenses to kill the tumor. Only Merck's (MRK) Keytruda has higher market share in immuno-oncology.

The market for cancer is immense, with the Centers for Disease Control and Prevention reporting about 600,000 U.S. cancer deaths in 2016. That figure is expected to rise within a decade to overtake heart disease as the number one killer in the country. And of all cancers, non-small cell lung cancer is the most profitable, thanks to it being the most common kind due to the large prevalence of smoking around the world. 

Opdivo was originally developed in 2014 to treat lung cancer, but the company has found it to be highly effective against numerous PD L1 bearing tumors as well. More promising is the fact that, while the drug by itself has minimal effectiveness against non-PD L1 tumors, in combination with other drugs its effectiveness seems to be greatly increased.

For example, trials show that the combination of Opdivo + Yervoy (another Brystol-Myers cancer drug) results in a 50% reduction in tumor size for 35% of patients compared to 12% for standard chemotherapy. 

Overall, Brystol-Myers has one of the industry's largest development pipelines with 82 clinical trials underway, including: 

  • Oncology: 61 ongoing clinical trials to treat over 50 types of cancer, including 17 new trials for expanding Opdivo indications by over 30 tumor types.
 
  • Immunology: 9 clinical trials with priorities in lupus, rheumatoid arthritis and inflammatory bowel disease.

  • Cardiovascular: 6 clinical trials, primarily for heart disease

  • Fibrotic diseases: 5 clinical trials, mostly lung and liver treatments

The company's biggest short to medium-term growth potential comes from expanding Opdivo indications to numerous cancer types, such as Renal cancer which kills over 40,000 people per year in the US, Europe, and Japan. The five-year survival rate for that cancer is just 12%, meaning that Opdivo has a very low bar to clear to receive regulatory approval for that indication. 

That's also true for liver cancer, which Brystol is also testing Opdivo against. The five-year survival rate for liver cancer is about 5%, which means that if Opdivo proves as effective as it has against other tumor types, it could increase its already high 55% market share for this disease. 

Gastric cancer is another major treatment market, with a 5% survival rate and 80,000 annual patients in the US, Europe, and Japan. Early trials for Opdivo indicate a 68% response rate which could potentially make it the dominant market leader for that indication. 

Brystol-Myers is also very adept at making strategic partnerships with other big drug companies to help spread out the risk and cost of drug development. For example, it developed Eliquis with Pfizer and recently signed a $3.6 billion deal with small biotech firm Nektar Therapeutics (NKTR) to secure a minority stake in its drug NKTR-214. 

With Nektar, clinical trials are studying how a combination of Opdivo and NKTR-214 can help treat melanoma, kidney cancer, and lung cancer. In other words Brystol-Myers is betting big that various combinations of its cancer-fighting superdrug with other medications will allow it to greatly increase the amount of cancer types it can treat, keeping Opdivo sales growing strongly for years. 

All told, analysts expect Opdivo sales to reach $11 billion by 2023, more than doubling their level in 2017.  

Besides its portfolio of fast-growing cancer drugs, Bristol-Myers also gains advantages from its large size, which provides the company with substantial resources and economies of scale. The company has one of the largest sale forces in the industry, highly efficient manufacturing channels, and one of the largest R&D budgets of any drug maker. 

In fact, Brystol-Myers spent $6.4 billion, or about 30% of sales, on R&D in 2017, with over 10% of its investment used for Opdivo trials. Despite the highest spending on R&D of any of its major peers, Brystol-Myers still managed to generate above-average profitability with a 20% free cash flow margin.

For 2018, management expects to increase R&D spending by a high single-digit pace, but continued strong sales of its blockbusters (plus the new lower corporate tax rate) should still drive mid to upper single-digit earnings growth, a similar pace compared to 2017. 

Another key advantage Brystol-Myers has is it's strong balance sheet. Many drug makers take on large amounts of debt in order to acquire large rivals to help drive growth. However, Brystol-Myers tends to stick to much smaller, bolt-on acquisitions (five since 2014). 

This has allowed the company's debt burden to remain very low at $8 billion, with $6.8 billion in cash on the balance sheet. Thanks to its financial conservatism and very healthy leverage ratios, Bristol-Myers enjoys an A+ credit rating and low borrowing costs. 

In a highly capital-intensive and acquisition-heavy industry such as pharma, financial flexibility is a strong competitive advantage. Besides having the ability to ramp up investments in promising new drugs and make opportunistic acquisitions, Bristol-Myers also boasts one of the safest dividends in the industry. 

In fact, Bristol-Myers has managed to maintain or grow its dividend for over 25 years, and has raised its payout for nine consecutive years.

Overall, analysts expect Bristol-Myers' strong pipeline of drugs to fuel about 3% annual sales growth over the next decade. Combined with ongoing cost cutting, improving margins, and steady buybacks, the company's annual earnings and dividend growth could sit in the high single-digit to low double-digit range. 

However, this is still a sector that is fraught with high risks, which could potentially cause such growth forecasts to significantly miss the mark.

Key Risks

Few industries are as hard to predict as pharmaceuticals. Not only must drugs go through a very long and expensive drug trial process, but they can fail at any time. 

For example, Opdivo was being tested as a first line treatment against non-small cell lung cancer in a 2016 study. The drug failed to show it was more effective than standard chemotherapy, which is why Keytruda is now the first line treatment for that disease. That single drug trial failure is expected to ultimately lop $2 billion off the drug's potential peak sales, which previously were estimated at $9 to $12 billion. 

In addition, while an approved drug enjoys patent exclusivity that ensures fat margins for a time, keep in mind that drug patents, which usually are for 20 years, get granted when a drug is first submitted. In other words, while a drug may enjoy patent protection for 20 years, 10 to 15 years of that period can be tied up in drug trials and testing, reducing the number of years that a company can enjoy blockbuster profits. 

And when those patents expire, a large hole can be created quickly. 

Brystol-Myers was one of the pioneers in Hepatitis C treatments, as well as several other virology medications. However, many of those drugs have now lost patent exclusivity, and sales have begun to collapse at a quick rate. For example, here are how Bristol-Myers' post-patent drugs performed in 2017:

  • Baraclude (5.1% of sales): -12%
  • Sustiva (3.5% of sales): -32%
  • Reyataz (3.4% of sales): -23%
  • Hepatitis C franchise (2% of sales): -74%

Generic (or biosimilar) competition can quickly cause a once-strong drug's sales to fall off a cliff. This creates an endless problem of patent cliffs forcing a company to constantly develop successful new drugs, or acquire them via acquisitions, just to keep sales growing at a relatively modest pace. 

The patent cycle also creates high sales, earnings, and cash flow volatility, which isn't very conducive for long-term dividend growth in most cases. For example, while Bristol-Myers' dividend track record may be one of the most reliable in the industry (in terms of not cutting its payout), the firm's 20-year dividend growth record averages just 3.7% per year. 

And speaking of acquisitions, the drug industry is one of the most prone to M&A activity which comes with high execution risk. A drug maker needs to be careful to not overpay for a deal, achieve expected cost synergies, and have the drug pipeline it acquires pan out in trials. Even if all the stars align for an acquisition, rival drug makers launching slightly different versions of medications can end up stealing market share and reducing a drug's pricing power. 

This is why many of the most successful drug makers, such as Johnson & Johnson (JNJ), have diversified into non-pharmaceutical businesses such as over-the-counter (non-patented) drugs and medical devices. These other businesses help to create more stable cash flow that can reliably be invested in high-margin pharma activities while also smoothing out overall earnings and dividend growth over time. 

Bristol-Myers has gone in the opposite direction, choosing to focus exclusively on patented medications and maintain a fairly concentrated drug portfolio. Therefore, the company's future cash flow volatility is likely to be greater than many of its peers. 

Finally, it's worth mentioning that virtually all drug makers face risks from legal liabilities (from lawsuits if a drug ends up hurting consumers) and legislative changes. 

Specifically, rising drug costs over time (Opdivo costs about $13,500 monthly per patient, according to The Wall Street Journal) have raised the ire of many politicians around the globe, increasing the risk that government healthcare programs may find a way to cap drug prices and hurt the margins of pharma companies. 

Closing Thoughts on Bristol-Myers Squibb

Bristol-Myers Squibb has an impressive long-term track record of navigating the volatile pharma industry to deliver higher earnings and dividends over the course of several decades. The company's early entrance into biological drugs, and immuno-oncology in particular, has created a potentially long growth runway in the lucrative oncology field.

Additionally, Bristol-Myers' industry-leading economies of scale, vast R&D budget, and large pipeline of new medications (as well as expanded Opdivo indications) mean that the company seems likely to enjoy rising sales, earnings, and cash flow over at least the next several years.

Combined with a rock solid balance sheet, these factors result in one of the safest dividends in the industry. However, investors need to realize that Bristol-Myers' focus on just a few key patented medications (top 10 drugs account for 90% of sales) means that its business results will likely be very volatile. 

Risk averse investors, such as retirees looking to live off dividends, might want to stick with more diversified pharma companies such as Johnson & Johnson, or even avoid the space altogether in favor of simpler businesses. 

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