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Companies mentioned: ABBV, AGN, BMY, AMGN, MRK, PFE.
AbbVie (ABBV) Riding Humira to the End
AbbVie’s performance in the first quarter of 2016 was nothing short of impressive, as the firm grew revenue by more than 18% on an as reported basis from the year-ago period. Humira (arthritis), the company’s headlining drug, sales increased nearly 15% as reported. New drug Imbruvica (leukemia) showed solid momentum in the quarter, and AbbVie received two approvals for the expansion of the Imbruvica as a first line therapy for chronic lymphocytic leukemia. The treatment is expected to play a key role in the future of the company, especially after its patent on Humira expires in December of this year. The firm also added two important late-stage pipeline treatments recently through the acquisition of Stemcentrx and a collaboration with Boehringer Ingelheim.
AbbVie’s bottom line experienced solid improvement over the same period in 2015 as well, with adjusted operating margin expanding 3 percentage points thanks in part to a material reduction in selling, general, and administrative spending. Adjusted diluted earnings per share jumped more than 22% on a year-over-year basis to $1.15 as a result of the strong margin expansion. Cash from operations benefitted materially from the bottom-line growth in the quarter, advancing 34% from the year-ago period and pushing free cash flow nearly 40% higher to just over $2 billion.
Strong free cash flow generation will be as important as ever for AbbVie moving forward. The firm had ~$23 billion in net debt on its balance sheet at the end of the first quarter of the year, but it is also issuing nearly $8 billion in debt in mid-May. We’re anticipating the proceeds from the debt issuance to go towards M&A activities to attempt to replace the coming loss of exclusivity of Humira, which poses a major threat to the firm. The drug accounted for approximately 60% of revenue in the first quarter, and though it will not lose the entirety of this revenue stream at the end of the year, it can be expected to erode significantly.
However, AbbVie has a strong late-stage pipeline, and it continues to add to that strength. Our fair value estimate of $69 per share assumes solid top-line growth in coming years due to a quality pipeline and execution of that pipeline. The firm’s dividend has solid growth potential as well, but the performance of shares will ultimately hinge on whether or not the company is able to mobilize its late-stage pipeline strength to replace the coming patent expiration of Humira.
Allergan (AGN) Branded Products Deliver
There has been a lot of moving parts for the company called Allergan over the past few years. Actavis completed its purchase of Allergan in March 2015 and subsequently changed its name to Allergan, and now the firm is in the midst of two major deals in the pharmaceutical space. Best Ideas Newsletter portfolio holding Teva Pharmaceuticals (TEVA) is working to complete the ~$40 billion acquisition of Allergan’s generics portfolio, while the rest of Allergan had entered an agreement to be purchased by Pfizer (PFE), only to have that deal nixed as it was the target of new tax laws from the US government.
Costs associated with the failed Pfizer deal weighed on Allergan’s GAAP earnings in the first quarter of 2016. The firm reported a GAAP loss from continuing operations of $0.38 in the quarter due to acquisition-related expenses from past deals (including assumed R&D spending) as well as the aforementioned expenses related to the Pfizer transaction. The company’s total net revenues leapt more than 48% in the quarter from the year-ago period thanks to even stronger growth in its reported branded net revenue. This translated into non-GAAP earnings per share growth of 15% on a year-over-year basis, with the majority of the difference between the GAAP and non-GAAP measure coming from amortization costs associated with acquired intangibles such as product rights.
The non-GAAP earnings strength helped Allergan more than double its cash from operations, which led to the firm nearly tripling free cash flow from the comparable period of 2015. This strong free cash flow generation will remain necessary after Allergan’s deal with Pfizer fell through, as the company has total debt of nearly $43 billion on its balance sheet compared to only ~$2.3 billion in cash, cash equivalents and marketable securities.
A great deal remains up in the air at Allergan at the moment. It is expected that Teva will be able to close its acquisition of Allergan’s generics portfolio in June 2016, “Teva Bounces After Strong First Quarter (May 2015),” and we are disappointed in the government’s intervention with the firm’s deal with Pfizer, “Treasury Erects Iron Tax Curtain (April 2015).” Management has a lot on its plate at the moment as its strategy has clearly been impacted by the scrutiny its deals came under as of late. A company with such a significant debt level and uncertainties surrounding it makes little sense to us as an investment consideration at this point in time.
Bristol-Myers Squibb (BMY) Free Cash Flow Dives
Bristol-Myers Squibb reported solid top-line growth in its first quarter of 2016 April 28. The firm grew revenue 9% from the year-ago period thanks to strong sales growth from drugs Opdivo (various forms of cancer) and Eliquis (stroke prevention), as well as growth in its Hepatitis C franchise. The company’s US operations led the way in terms of top-line growth, with domestic revenue jumping 24% over the comparable period of 2015 while international revenue fell 7%.
A declining gross margin and increased marketing, selling, and administrative expenses offset the top-line growth as it relates to the firm’s bottom-line performance in the quarter. GAAP earnings per share were flat on a year-over-year basis, but when excluding specified items, non-GAAP earnings per share advanced 4%. The slight bottom-line improvement did nothing to boost cash from operations in the period, which came in as $386 million in cash used in operations. Free cash flow generation was also negative as a result.
However, one quarter of negative free cash flow is not the end of the world for Bristol-Myers, though it is certainly not a bright spot. As of the end of the first quarter of the year, the company had a net cash (including current and non-current marketable securities) position of nearly $1.3 billion, a major advantage over the two previously discussed companies. Bristol-Myers was granted a breakthrough treatment designation for Opdivo during the quarter, reassuring the firm’s high expectations for the future of the drug.
Despite the flat performance of Bristol-Myers’ earnings in the first quarter of 2016, the company raised its 2016 GAAP and non-GAAP earnings per share guidance ranges. Non-GAAP earnings per share are now expected to be in a range of $2.50-$2.60 compared to previous guidance of $2.30-$2.40. The guidance increase is based on the assumption of revenue increasing in the low-double digit range, marketing, sales and administrative costs decreasing in the low-single digit range, and research and development costs increasing in the low-double digit range.
We’re fans of Bristol-Myers’ innovative portfolio, but shares are too rich for our taste at the moment. Shares are trading at a forward P/E multiple in the mid-30s, and our fair value estimate of $61 per share further supports our lack of interest in the firm at current price levels.
Amgen (AMGN) Raised Guidance After Strong Quarter
Amgen delivered excellent first quarter operating results in its quarterly report April 28. The firm grew every important metric on its income statement by double-digit rates on a year-over-year basis, beginning with total revenue growth of 10%. Total product sales helped drive revenue growth, as it increased 7% from the year-ago period. Enbrel (autoimmune diseases) was the leader of the pack with 24% sales growth compared to the first quarter of 2015.
Moving down the income statement, adjusted operating income advanced 17% (outpaced by GAAP operating income at 19%), and adjusted earnings per share jumped at the same rate (again outpaced by the GAAP measurement at 18%). The firm’s operating margin improved 4.4 percentage points from the comparable period in 2015 as declines in cost of goods sold and research and development costs as percentages of revenue more than offset an increase in selling, general and administrative spending as a percentage of revenue.
Despite the strong bottom-line growth, Amgen delivered relatively flat cash from operations and free cash flow in the quarter, with both measurements of cash flow growing only 0.4% from the year-ago period. $1.8 billion in free cash flow in one quarter is certainly nothing to scoff at, however. The company now holds a net cash and investments position of ~$400 million, a solid improvement from the first quarter of 2015 when it had a net debt position of nearly $3 billion.
After its strong first quarter performance, Amgen raised its full-year 2016 guidance ranges for both total revenue and adjusted earnings per share. The company now expects revenue to be between $22.2 and $22.6 billion, compared to previous guidance of $22-$22.5 billion, and adjusted earnings per share guidance is now a range of $10.85-$11.20, up from the previous range of $10.60-$11.00.
We’re fond of Amgen’s track record in the commercial execution of its product portfolio, and this strength was on full display in the first quarter of the year. The firm’s Dividend Cushion ratio of 2.7 benefits from its healthy balance sheet, but a dividend yield of ~2% is not all that enticing. Additionally, we think the market has shares appropriately valued at the moment, keeping us squarely on the sidelines.
Merck (MRK): Keytruda the Key?
Merck remains focused on the development of its business. Meanwhile, first quarter of 2016 revenue declined 1% from the year-ago period due to a 4% negative impact from currency headwinds. The firm’s two top-selling treatments left a bit to be desired in terms of sales growth in the period; Januvia (diabetes) advanced sales by 1% in the quarter, and Zetia (high cholesterol) brought in sales at a level relatively flat with the first quarter of 2015.
Merck’s bottom line fared much better than its top line in the first quarter of the year, as non-GAAP earnings per share increased 5% on a year-over-year basis to $0.89 thanks to lower operating costs in the areas of materials and production, marketing and administrative, and research and development. Despite the improvement on the bottom line of the income statement, the firm’s cash flow generation did not fare well in the quarter.
Cash from operations declined 5.5% from the year ago period, dragging free cash flow down nearly 10% as capital expenditures grew from the comparable period in 2015. Though free cash flow was pressured in the first quarter of 2016, Merck’s balance sheet remained healthy. The company holds a slight net debt position of less than $300 million as of the end of the quarter, a very healthy level compared to some of its peers.
Merck is just beginning to overcome losses of exclusivity on key drugs in recent years, and the Keytruda (cancer immunotherapy) franchise is playing a huge role in its comeback. The ongoing launch of the product in markets around the globe is being augmented by additional supplemental filings, and the drug recently secured a fourth breakthrough therapy designation. This improving outlook is part of what led management to raise its full-year 2016 non-GAAP earnings per share guidance. The firm now expects the measure to come in a range of $3.65-$3.77, compared to previous guidance of $3.60-$3.75.
Though the momentum appears to be beginning to shift at Merck with respect to its recovery from recent revenue trends, we are not particularly enticed by the firm as an investment consideration. We think the market has shares priced right at the moment, as they are currently changing hands very close to our fair value estimate of $55.
Pfizer (PFE) Reports Strong Operational Performance
Pfizer reported impressive revenue growth of 20% in the first quarter of 2016 from the year-ago period. Excluding the impact of the September 2015 acquisition of Hospira, first quarter revenue increased 15% from the comparable period in 2015. The firm’s Innovative Products segment–which consists of Global Innovative Products, Global Vaccines, Global Oncology, and Consumer Healthcare divisions–grew revenue 23% on a year-over-year basis, with the Global Oncology division nearly doubling its revenue. The company’s Established Products benefited from the addition of legacy Hospira operations as it advanced revenue 17% from the year-ago period. Excluding the impact of the addition of Hospira, the segment’s revenue fell 7% from the comparable period of 2015.
Pfizer reported solid bottom-line growth in the first quarter as well. Non-GAAP earnings per share leapt more than 31% on a year-over-year basis to $0.67 thanks in part to lower research and development costs and materially lower taxes. The strong earnings performance led to cash from operations more than doubling from the year-ago period, which in turn more than tripled free cash flow generation. Growing free cash flow generation is always a positive sign for a company, especially as Pfizer continues to repurchase excessive amounts of stock. The firm swung to a net debt position of nearly $5.8 billion in the first quarter of 2016 from a net cash position of nearly $400 million at the end of 2015.
Despite the solid operating performance in the first quarter of the year, Pfizer’s failed deal with Allergan has dominated headlines around the company as of late. The firm’s $160 billion purchase was scrapped after a US tax rule change increased the scrutiny on tax-inversion deals like the one proposed in the deal agreement. While we grow increasingly disappointed in the US government’s overreaching qualities, we feel Pfizer will remain one of the strongest pharmaceutical companies on the market without the merger. The company owes Allergan a $150 million breakup fee as a result of the deal failing.
Shares of Pfizer are fairly valued on the market at the moment, in our opinion, based on our fair value estimate of $35. The company’s dividend has fully recovered from its cut amid the depths of the Financial Crisis, and its Dividend Cushion ratio sits at a solid 2.2 while its yield is well above average at ~3.6%. The dividend is not quite enough for us to be interested in the firm at current price levels, however.