Sanofi SA Looks Like One Of The Better Bargains In Big Pharma

Even with the recent weakness in the market, there is no surfeit of cheap pharma stocks. Maybe it's not so surprising that Sanofi (NYSE: SNY  ) , a company which has taken a different path than most of its Big Pharma peers, stands out as an exception. Sanofi has not concentrated so keenly on the oncology or anti-inflammatory spaces, and the company has a sizable direct presence in many emerging markets.

While Sanofi's guidance for 2014 was both disappointing and short on details, I think these shares are worth consideration. Strong franchises in diabetes, rare diseases, and vaccines generate good cash flow, and a broad pipeline gives the company a more diversified business mix. My growth expectations are higher than for most pharma companies, but I believe the shares ought to trade in the $50's today.

In-Line Results, With Weak Guidance
Sanofi's revenue declined in 1% on a reported basis, but rose more than 6% in local currency. Pharma revenue was up 1% as reported and more than 8% on a currency-adjusted basis, with Lantus (which contributes more than 15% of the company's revenue) up 13%. Genzyme also continues to deliver strong growth, with sales up more than 30% in local currency and double-digit growth across much of the business. Vaccines (flat) and animal health (down 6%) weren't so impressive, while consumer was up more than 6%. 

Margins were mixed, as gross margin was up a bit but below expectations on mix and vaccine manufacturing issues. Operating income was up 17% as reported, though, and basically in line with expectations. Guidance was problematic. Management was light on specifics (and has a reputation for being conservative), but it looks like sales for 2014 are going to be about 10% lower than expected on a reported basis. More than half of that is due to currency, which mitigates the disappointment to some extent, but a 3% to 5% lower number in constant currency is not a positive development.

Holding Market Share In Diabetes
Not unlike Lilly and Novo Nordisk (NYSE: NVO  ) , Sanofi is finding it challenging to really move its diabetes franchise forward in a big way. Pricing on Lantus has been pretty strong, but the data on the new U300 insulin have been more "solid" than "game-changing". That's not as big of a concern as the FDA rejection that Novo Nordisk has had to work through on Tresiba, but it does mitigate some of the growth potential. Likewise, I haven't seen much from Lyxumia (the company's GLP-1 drug) to make me think it's going to redefine the GLP-1 space that Novo basically dominates.

On the Lilly front, Sanofi has filed suit against Lilly over the latter's biosimilar Lantus product. Barring summary judgment against Sanofi, this should stall Lilly by at least 30 months. With that delay, there's a better chance of U300 getting to market and Sanofi switching patients over from Lantus to U300. Lilly also has a stronger portfolio of diabetes medications outside of insulin, with a GLP-1 (dulaglutide), DPP-IV (Tradjenta), and SGLT2 (empagliflozin) drug. Perhaps Sanofi could be interested in Lexicon's unpartnered SGLT1/2 inhibitor, but that opportunity has been available for some time now.

What this all means to me is that the diabetes space is likely to remain more or less as it is – highly lucrative for Lilly, Novo, and Sanofi, but a difficult area in which to really affect real market share growth. Sanofi is likely going to push Lantus pricing higher and look to compete aggressively with Novo in the growing emerging market opportunity in insulin, but Novo and Lilly aren't going to sit around and just cede share or revenue to Sanofi.

Will Diversification Pay Off?
Big Pharma has taken an interesting turn of late, with companies like Bristol-Myers and Merck increasingly winnowing down their research focus. With that, there is a lot of R&D money going into oncology and inflammatory conditions (rheumatoid arthritis, for example). There are over 500 compounds in clinical development for oncology (though the real number is likely closer to 200 due to double-counting) and more than 20 for RA, and though many will fail that is a lot of effort being devoted to a small number of targets. 

Sanofi is definitely staking out a different approach. Sanofi's efforts in oncology haven't gone particularly well, though the company's partnership with Regeneron does include anti-inflammatory targets. Sanofi's pipeline is considerably broader in terms of the therapeutic areas it addresses (including strong efforts in vaccines and rare diseases) and that could pay off down the line in terms of larger market shares and more stable cashflow.

The Bottom Line
The outlook for Sanofi's MS drug Lemtrada is still quite uncertain, but I do believe that the company's PSCK9 cholesterol drug (partnered from Regeneron) and IL-6 rheumatoid arthritis drug could deliver $2 billion in combined revenue by the end of this decade. Coupled with other existing platforms and the pipeline, I believe Sanofi could deliver revenue growth of nearly 4% over the long term, putting it at the high end of Big Pharma and supporting mid-single digit free cash flow growth.

I calculate a fair value of around $55 for Sanofi, but management's weak guidance underlines some of the risks, particularly as the company targets growth in emerging markets. Fierce competition in diabetes (and the possibility of biosimilars) is definitely a threat, but Sanofi looks like one of the better risk-reward opportunities in Big Pharma today.

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