Negative Net Income is a fundamental red flag for BMY – but it’s still a good long-term value

There is a lot of fundamental data that I rely on to help paint an overall picture about underlying strength of any stock I might consider using for a value-based investment. While some fundamental investors prefer to work with easy-to-reference, quick-glance data like earnings per share, I prefer to expand my view of a company’s profitability by also looking at the company’s pattern of Net Income and Free Cash Flow growth.

Earnings per share is a useful, standardized method of describing a company’s profit in a given period on a per-share basis; but it is also a number that can be calculated a number of different way, which means that there is quite a bit of subjectivity a creative financial manager can inject in a company’s earnings. On the other hand, Net Income – income remaining after expenses – and Free Cash Flow – the cash left after operating expenses and capital expenditures – are generally more straightforward measurements with less subjectivity. I like to use all three measurements together. A pattern of growth in all three measurements is the ideal and best-case scenario, while divergences in one or more of these measurements relative to the others can signal problems that need to be examined in more detail.

One of the stocks that has become like an old, familiar friend for me since 2019 is Bristol-Myers Squibb Company (BMY). This is a stock that I’ve followed throughout 2020 and used a few times to nice overall effect, but that hasn’t drawn a ton of attention from market analysts and talking heads as most of the focus for the past year and even into the first quarter of 2021 has been on fractious political rhetoric, as well as ongoing reality that COVID-19 news will continue to loom over just about every discussion, financial, political or otherwise as the year progresses.

Despite recent progress in total vaccinations and declining infection and hospitalization trends, COVID has pushed health care facilities and medical professionals to their limits. I think part of that is a reflection of the reality that, besides the pandemic, there is still a need for other types of health care as well. I think that is where BMY has an important role to play not only in a society but in a smart investor’s watchlist right now. From its own bear market low, the stock has rebounded by more than 33%, but has retraced about -11% from its 52-week high, reached in January of this year when the stock tested pre-pandemic levels around $67 per share. A big part of the stock’s performance over the last nine months, I think can be attributed to the pharmaceutical industry’s resilience this year as one of the market’s few bright spots during the initial part of the health crisis. In November of 2019, the company completed the acquisition of Celgene, with the first set of combined annual financial statements coming in their most recent earnings report. One of the elements that I think is drawing some bearish sentiment is the fact that Net Income for the combined business turned sharply negative over both the last twelve months and the most recent quarter.

My read on that negative pattern is that it reflects challenges imposed not only by the integration of two large businesses but also by practical difficulties forced on the entire business world in the face of the COVID pandemic. There is no denying that 2020 had an operational impact on the company, but even so BMY still boasts one of the strongest, long-term development pipelines in the Pharmaceutical industry that became even less concentrated and more diversified with the completion of the Celgene acquisition, and dovetailing with what I think will inevitably be an increased level scrutiny and attention – appropriately so, and in the long run, to our collective benefit – on proper health and care on an individual level. While I think the reduction in Net Income is ultimately a temporary concern, it is also true that it is one of the reasons the long-term, “fair value” target my analysis generates dropped following that last earnings report. Even so, the company’s other strengths, including robust, stable Free Cash Flow growth and a balance sheet with healthy liquidity to absorb its current negative Net Income. The value proposition is boosted by the stock’s current bearish momentum, and despite the drop versus previous quarters, remains very attractive. Let’s run the numbers.

Fundamental and Value Profile

Bristol-Myers Squibb Company is engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of biopharmaceutical products. The Company’s pharmaceutical products include chemically synthesized drugs, or small molecules, and products produced from biological processes called biologics. Small molecule drugs are administered orally in the form of a pill or tablet. Biologics are administered to patients through injections or by infusion. The Company’s products include Empliciti, Opdivo, Sprycel, Yervoy, Eliquis, Orencia, Baraclude, Hepatitis C Franchise, Reyataz Franchise and Sustiva Franchise. It offers products for a range of therapeutic classes, which include virology, including human immunodeficiency virus (HIV) infection; oncology; immunoscience, and cardiovascular. Its products are sold to wholesalers, retail pharmacies, hospitals, government entities and the medical profession across the world. BMY has a current market cap of $135 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by 19.7%, while sales increased about 39.3%. In the last quarter, earnings were declined -10.43% while sales were 5% higher. As previously mentioned BMY’s Net Income versus Revenue pattern is a red flag that bears watching; over the last twelve months this number was -21.2%, and deteriorated to -90% in the last quarter. I attribute the biggest portion of that clearly negative pattern to the transitory period required to integrate two huge operations into a single company. Add to the mix the complication of the pandemic, and I think that while the negative numbers are important, they are a temporary risk element. Improvement in these numbers in the quarters ahead would provide validation of that viewpoint.

Free Cash Flow: BMY’s Free Cash Flow is healthy, at $13.3 billion. That is marks a pattern of steady improvement through the past year, from $11.7 billion in the quarter prior and $9.7 billion at the beginning of 2020. The current number translates to a Free Cash Flow Yield of 9.7%. The strength in this number is a useful counterpoint to the negative Net Income pattern I just described and implies that the company’s ability to service its debt, maintain its dividend and keep business growing remains intact.

Debt to Equity: BMY has a debt/equity ratio of 1.28 – a number that jumped from .82 in the quarter prior and is primarily attributed to the debt assumed during the completion of the Celgene deal. As of the last quarter, cash and liquid assets were $15.8 billion versus $48.3 billion in long-term debt. Pre-merger, BMY had just $5.3 billion in debt versus more than $8 billion in cash; however management as well as most analysts predicted the deal would be immediately accretive, even allowing for the current, negative Net Income impact. So far that appears to be the case, which means the high debt level continues to be more than serviceable.

Dividend: BMY pays an annual dividend of $1.96 per share, which at its current price translates to a dividend yield of about 3.23%. Management increased the dividend from $1.80 per share, per annum in mid-2020. The increase is a strong signal of management’s confidence in its business strategy and overall financial strength.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $96 per share. That is below the $112 level my analysis yielded prior to the last earnings report, but even so suggests that BMY is very undervalued, with 60% upside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above displays the last year of price activity for BMY. The red diagonal line traces the stock’s upward trend from March 2020 at around $46 to its peak in January at around $67; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s rise off of its bear market low is clear; but more interesting is the stock’s pattern since November. Since pushing to a new high at the beginning of that month a little below $66, the stock retraced to find support at around $60. It surged briefly at the beginning of the year, driving to a little above $67 before dropping back again from that point. Since early February, the stock appears to have found support again around $59, where the 38.2% retracement line rests. A push above immediate resistance at around $62 could give the stock room to push to about $65.50 to next resistance, with additional upside to its recent high at around $67 if bullish momentum picks up. A drop below $59 has downside to about $56.50 where the 50% retracement line sits for next support.

Near-term Keys: The red flag in BMY’s fundamental profile is the negative Net Income pattern, and it frankly is a big one; but I continue to believe that is a lingering remnant from the net, temporary effect of integrating Celgene into its organization. Their strong pattern of Free Cash Flow growth, on the other offers a counterpoint that I think underscores their overall fundamental strength, even amid some current difficulties. The stock is only about -11% away from its 52-week high, but given the underlying fundamental strength, I still think the stock offers a fantastic value proposition far above that point. If you prefer to focus on short-term trading strategies, a push above $62 could offer a signal to consider buying the stock or working with call options, using $66 as a near-term profit target. A drop below $59, on the other hand could offer a good signal to think about shorting the stock or working with put options with an eye on $56.50 as a useful price target on a bearish trade.

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