Wednesday, November 24, 2010

An Indepth Look on Sanofi-Aventis

I hold pharmaceutical companies because they are good defensive plays, offer decent dividend income and are currently fairly valued. Also, I believe that in the long run, aging baby boomers in the western world and people rising to middle class in the east will drive up the revenues big time. While food, water and shelter are high on everybody’s priority list, prevention and treatment of illness is not far behind. The modern medicine can do wonders and the ever increasing number of pharmaceutical products helps people to increase quality of life and even life expectancy.



VEGF Trap (aflibercept) molecule. Copyright: Dominique Sarraute. For press use only.
COPYRIGHT 2004-2010 SANOFI-AVENTIS ALL RIGHTS RESERVED.


Introduction to Sanofi-Aventis

Sanofi-Aventis (SNY) caught my eye when browsing the portfolio of Berkshire Hathaway (BRK.A/BRK.B). At year end 2009 it was the 9th largest common stock investment of Warren Buffett valued at approximately $2 billion. Looking at information available via Datarom.com also two other famous value investors have Sanofi-Aventis in their portfolio. This is not much compared to U.S. based companies Pfizer (PFE) and Johnson & Johnson (JNJ) that are much more widely owned among the tracked investors. Makes me wonder if there is a U.S bias among the tracked investors or whether there is something wrong with the stock compared to the others in the same sector.

French Sanofi-Aventis is one of the biggest drug manufacturers in the world. It has roughly $85 billion market capitalization and annual sales of $40 billion (2009). The product portfolio of Sanofi-Aventis includes vaccines, prescription medicines, generics, consumer health care and animal health. It has worldwide presence and 100,000 employees in over 100 countries.
Sanofi-aventis generates a substantial share of its revenues from the sale of certain key products. Ten best selling products of Sanofi-Aventis:


Out of all sales 87% come from prescription medicines and the 10 best selling products deliver almost 50% of top line.


Patent protection and regulatory exclusivity of existing products

Without patent protection and regulatory exclusivity products can be manufactured and sold by anybody. When so called generic products enter the market, sales of the original branded product will fall dramatically as generics are typically sold at significantly lower price. Therefore, the future profits of current products of any pharmaceutical company depend heavily on both patent protection and regulatory exclusivity.
Sanofi-Aventis own a broad portfolio of patents, patent applications and patent licenses worldwide. These patents relate to active ingredients, pharmaceutical formulations, product manufacturing processes, intermediate chemical compounds, therapeutic indications/methods of use, delivery systems and enabling technologies. Regulatory protection including obtained pediatric extensions of currently 10 best selling products is summarized in the following table:


Table is based on data from 2009 annual report.

Notes:

*) In most of EU
**) Later filed improvement patents. Patent protection of Taxotere beyond Nov 2010 was invalidated recently by Delaware court.
***) Sales figure for Stilnox includes also some related products with different trade name: Myslee, Ambien and Ambien CR.



Looking at the above table, one can see that the 10 best selling drugs have no regulatory exclusivity left after this month in EU and US and also the patent protection is getting quite thin in the next two years. In five years, the protection will be almost non-existent. Most of the “big pharmas” face the same problem, so this is an industry-wide problem. Therefore, it is no wonder Sanofi-Aventis has been busy in acquisition front.


Acquisitions


Looking at various acquisitions done in 2009 and 2010, Sanofi-Aventis is expanding business to generics and consumer health products as well as strengthening its R&D pipeline and product lines. The 2009 acquisitions include:
• Zentiva N.V. - a branded generics group with products tailored to the Eastern and Central European markets
• Laboratorios Kendrick - one of Mexico’s leading generics manufacturers
• Medley - a leading generics company in Brazil.
• BiPar Sciences, Inc. - an American biopharmaceutical company
• Fovea Pharmaceuticals SA - a French biopharmaceutical R&D company
• Laboratoire Oenobiol - one of France’s leading players in health and beauty dietary supplements
• Chattem, Inc. - one of the leading manufacturers and distributors of branded consumer health products, toiletries and dietary supplements in the United States.
• Shantha Biotechnics - an Indian biotechnology company that develops, produces and markets vaccines to international standards
• Remaining 50% of Merial - a world-leading animal health company

The acquisitions and tender offer in 2010 are summarized in the following table:


The takeover offer for Genzyme (GENZ) is by far the largest undertaking and the tender offer has been covered widely in Seeking Alpha already so no need to dig deeper into that one:

Sanofi Takeover Offer for Genzyme: The Pressure Is On (October 5, 2010)
Sanofi-Aventis Makes Hostile Bid to Acquire Genzyme: Are They Overpaying? (October 5, 2010)
Sanofi / Genzyme Battle Likely to End Somewhere in the Middle (October 11, 2010)



R&D pipeline

The research and development pipeline of Sanofi-Aventis is full of products in different development phases and it’s quite frankly quite hard to assess the commercial potential of these drugs and whether some of the drugs in the early phases ever get even approved. Majority of late phase products are vaccines or related to either thrombosis or cancer treatment. Almost the same therapeutic areas describe the early phases of the pipeline except that there is nothing related to thrombosis and lots of drugs related to central nervous system.

Strasbourg Research Center: Protein dispensing in a eppendorf tube. Copyright : Antonin Borgeaud / Interlinks Image. For press use only.
COPYRIGHT 2004-2010 SANOFI-AVENTIS ALL RIGHTS RESERVED.

Somewhere in this pipeline there ought to be the next billion-dollar-a-year selling drugs. Without many of those, the annual sales and profits will decline. This in turn, starts the vicious cycle of cost cutting and then the 4-5 billion euro per year R&D budget gets cut down making the chances of hitting home runs even more remote. The R&D process typically takes 10 to 15 years from discovery to commercial product launch, so anything started this year won’t help the problem at hand in five years from now.

In addition to its own R&D, Sanofi-Aventis pursues a strategy of acquisitions, in-licensing and partnerships in order to develop new growth opportunities. Also, it is outsourcing R&D as explained in article “Sanofi Continues to Look Beyond Its Own Walls to Fill the Void From Drugs Going Off-Patent” published October 3rd in Seeking Alpha. It seems that outsourcing R&D is the trend among big pharmas.


Valuation


Sanofi-Aventis is currently trading at same level than it was back in 2005. With P/E ratio of 10 it looks cheap, but you have to keep in mind all the drugs going off patent. I have look at all the big pharmas selling around or below 10 and they all have the same problem. In short: the are not really cheap. Nor they are awfully expensive either. I won’t second guess Mr. Market what comes to companies as closely followed as these. Looking at P/B of 1.2, Sanofi-Aventis is by far the cheapest of all major drug manufacturers. It also pays nice dividend (4.5% yield). [Data source: finwiz.com]

I calculated from information available in Berkshire Hathaway 2009 annual report that Buffett had paid on average a bit over $80 for each share of Sanofi-Aventis. Given that two ADRs represent one actual common share, then you need to divide that average price by two to get ADR average pricing which becomes then $40.37. Sanofi-Aventis ADR was trading at $32.67 at the time of writing this article. This means 19% discount compared to the average purchase price of Mr. Buffett. Not bad.


A look at the latest quarterly report


Net sales and EPS were up 4.8% and 8.7% on reported basis for the first nine months compared to last year. Quarterly figures were less impressing. With constant exchange rates, both Net sales and EPS were actually declining when compared to figures year ago. The net sales of Pharmaceuticals, the largest segment by far, declined 3.5% mainly due to generics competition on Q3. All other segments were growing. Consumer health care and generics segments were demonstrating especially strong growth and so did emerging markets sales. Basically sales outside US and Western Europe were growing while sales inside these regions were declining.

Sanofi-Aventis has plans to cut down US sales force significantly and redeploy resources towards strategic priorities in 2011. The R&D to sales ratio is also trending down. In Q3 it was 13.9%. Net debt level was reduced in the first nine months of 2010 thanks to strong free cash flow. Profit margins stayed on very healthy levels.


Conclusion


Sanofi-Aventis was not my first choice in pharmaceutical/healthcare sector mainly due to very high amount of sales coming from products that face increasing generics competition in the next years. Also, pharmaceutical segment is quite dominating in the group unlike in Johnson & Johnson that have more balanced portfolio to stabilize the up and downs of pharmaceutical segment. However, there seems to be sufficient margin of safety in the current pricing. Also, the dividend yield is attractive. I am bullish for the healthcare and pharmaceutical segments in the long run due to aging population in the western world and rising standards of living in the east. Therefore, I find Sanofi-Aventis quite suitable to my defensive portfolio mostly made out of dividend and asset plays.

I bought Sanofi-Aventis today (NYSE: SNY, Paris: SAN).

1 comment:

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