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Sanofi-Aventis: High Yield, Low Valuation


Opportunity in Big Pharma



The drug industry is in trouble — at least that’s what the stock market is telling us. Many of the world’s largest pharma companies are trading at multiyear lows, and all of them seem to be facing several problems.

This is a big change from only a few years ago, when many pharmaceutical companies were trading at very high price-earnings multiples because of the consensus belief that aging populations in Asia, Europe and the United States would be a boon for anything pharma-related. Nothing has changed demographically. But pharmaceutical companies are now facing pressure from generic drugmakers challenging their patents as well as from governments trying to squeeze their margins.
   
Perhaps most importantly, however, big pharma is finding it increasingly difficult to launch successful new drugs following the removal of a few products because of possibly significant side effects. And cutting research and development budgets isn’t really an alternative, because R&D is the pharmaceutical industry’s lifeline. No R&D means no new drugs and no new revenues.
   
All these issues are important. But most of them are known and already accounted for in the valuation of large-pharma stocks. Hence, an interesting opportunity might present itself in the shares of French giant sanofi-aventis. The company, created in 2004 after the merger of Sanofi and Aventis, is the world’s third-largest pharma company in terms of revenues. American Depositary Receipts representing its stock are traded on the New York Stock Exchange under the symbol SNY.
   
Buying drug companies always carries a high degree of uncertainty, and sanofi-aventis is no exception. For example, generic manufacturers are challenging the patent protection of Lovenox, which along with Plavix and Ambien are sanofi-aventis’ main drugs. The loss of Lovenox would be another blow to the company’s earnings projections for the next few years. 
   


The company has a large pipeline of products in various stages of development. But it’s possible that none of these drugs will make it to market. Sanofi-Aventis also hasn’t launched a blockbuster drug since 2001, and 40 percent of its current revenues come from pharmaceuticals losing their patent protection by 2012. The company will have to come up with new sources of revenues or buy existing products to replace lost revenues.
   
In fact, sanofi-aventis’ current growth profile is so anemic that of 27 analysts covering the company, only three have a Buy rating on the stock. But what makes this stock worth studying is its valuation. The P/E ratio is low and probably already discounts many issues the company faces.
   
Its American Depositary Shares recently traded at around $36, or about 1.4 times book value. On current expectations for 2008, the company trades at 8 times earnings and offers a dividend yield of 4.5 percent. Hence, buying sanofi-aventis today is like buying a bond with the potential of future success in its R&D pipeline for free.
   
Revenues totaled $44.8 billion in 2007. Earnings per ADS were $3.54 in 2007 and are expected to grow in the low single digits in 2008. The company’s balance sheet is strong, with a debt-to-equity ratio of only 5 percent.
   
At least one investor believes there’s upside in sanofi-aventis. Over the past year, Warren Buffett built a 1.5-percent stake in the company at prices higher than today’s.




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