Finding the Turnaround: Bristol-Myers Squibb [Fool on the Hill] August 3, 2000

FOOL ON THE HILL: An Investment Opinion
Finding the Turnaround: Bristol-Myers Squibb

Wall Street's myopic perspective ("what's going to happen next quarter") provides opportunities for long-term investors. The professionals usually run from any company when it runs into trouble, even if it's a well-entrenched firm with huge competitive advantages. Investors with an investment horizon longer than a few months can find opportunities in these situations, particularly when a company's major problems are being addressed. Right now, Bristol-Myers Squibb looks interesting.

By Warren Gump (TMF Gump)
August 3, 2000

Watching the ebb and flow of Wall Street opinions is a humorous endeavor. In the span of a few months, you can see a stock go from being "a core, long-term holding for any portfolio" to something that "isn't where I'd put my money." Wall Street will valiantly stand by a company that steadily increases sales and earnings. However, if that same organization runs into business challenges caused by management turmoil, macroeconomic challenges, new product delays, or governmental regulation, they'll run like the plague. They're so scared of near-term uncertainties, that a company's dominant brands, tremendous financial resources, and a long history of success will be ignored.

A superb example of this is Proctor & Gamble (NYSE: PG), which has fallen 46% since the beginning of the year after announcing several earnings warnings and management changes. In just a few months, the stock has gone from being a safe, defensive play -- where investors were falling over themselves to pay 37x earnings at the beginning of the year -- to an outcast laggard that only adventurous folks would pay 20x earnings to buy.

What a weird, wacky world. People get excited and enthused about buying when prices are high, but are afraid when they find the same thing marked down in the bargain bin. I bet quite a few retailers would be enthused if consumers held those attitudes when shopping. Imagine how profitable the business would be. Sales would soar if you raised prices (and margins), but would suffer if items were put on sale.

Don't jump in
Just because a stock has been knocked down significantly and looks statistically cheap doesn't mean it'll make you money. In fact, personal experience has shown me that it's usually advantageous not to immediately invest in a stock that's been pummeled due to fundamental challenges. All too often, investor sentiment will worsen and the company will release more bad news before things get better.

You need look no further than Tricon Global Restaurants (NYSE: YUM) to find a recent example. I was attracted to this fast-food leader because of its sector-leading Pizza Hut, KFC, and Taco Bell franchises. In addition to controlling great brands, the company has been selling off company-owned units to franchisees to raise margins and pay off debt. I purchased shares because of these attributes, and the fact that the company was expected to have 15%+ earnings growth and traded for less than 10x earnings.

What I failed to evaluate was the reason people were avoiding the stock -- poor same-store sales performance and concern about earnings growth. When the company announced that Taco Bell's second-quarter sales fell below expectations and would likely do so for the rest of the year (along with earnings growth), the stock fell from a depressed $29 per share to $23 3/4 in less than two weeks. Even though the stock was statistically cheap relative to its growth, diminished investor sentiment drove the share prices even lower. I expect to ultimately make money on my Tricon investment, but avoiding this latest plunge would have been preferable.

An investing strategy
How could I have reduced the risk of participating in this latest Tricon decline? I should have followed my general rule of thumb when investing in "broken" companies -- figure out what's wrong with the company, put it on a watchlist, and wait for evidence that those issues have been addressed. You probably won't get in at the stock's low point using this strategy (other investors will also see these signs and bid a stock up), but the risk of a future blowup will likely be diminished.

I've been tracking Bristol-Myers Squibb (NYSE: BMY) since it ran into problems earlier this year. It now looks like investors' biggest concern about the company -- the ability to get new drugs approved -- is being overcome.

Bristol-Myers Squibb
Bristol-Myers is a major pharmaceutical company with products such as Pravachol, a cholesterol drug; Taxol, a cancer treatment; Glucophage, for Type 2 diabetes; Enfamil baby formula; and Excedrin pain-relief medicine. Since 1995, the company grew earnings 10%-15% a year, and it has a much longer track record of achieving success. Earnings are expected to hit $2.33 per share this year, $2.59 next year, and grow about 12% annually thereafter. Despite these prospects, the stock has fallen to $53 1/4 from a 52-week high of $79 1/4 and trades for 23x current-year earnings, a low multiple for a major pharmaceutical firm.

The stock has been knocked down on investor concern about the company's ability to obtain government approval for new drugs. This fear has been compounded by worries about impending generic competition for two major products, Taxol and Glucophage.

In March, Bristol-Myers announced plans to withdraw applications (with plans to resubmit them at a later point) to the Food and Drug Administration (FDA) for two colon-cancer drugs, UFT and Orzel. While investors were unnerved by this withdrawal, the stock rebounded quickly due to high hopes for Vanlev, a new blood-pressure drug expected to be approved by the FDA.

When the company announced the withdrawal of the Vanlev application in April, investors ran away from the stock and they haven't come back. Although Bristol-Myers expects to resubmit this application next year after additional studies are completed, the company has fallen out of Wall Street's good graces.

As a layperson, it's virtually impossible to tell what will happen to a compound in the FDA approval process. Watching a company pull three drug applications in a one-month period makes you question whether it understands the process very well. Why would you want to be invested in such a company? Until there's proof that the company can get drugs approved, you're going to want to stay away.

This week, the tide started shifting in Bristol-Myers' direction. The company announced FDA approval for Glucovance, a drug that should help the company maintain some of Glucophage's market share. It also announced the approval of Vaniqa, which helps prevent the growth of facial hair in women. These successes should help relieve concerns that Bristol-Myers can't get anything through the FDA approval process.

Certainly, Bristol-Myers isn't out of the woods. It still needs to get approval for major products like Vanlev and smaller products like Orzel. The company refiled its FDA application for Orzel, and studies to evaluate the safety of Vanlev are also in place, but nothing can be guaranteed. With a couple of recent product approvals under its belt, though, I'd rather watch the story evolve as a Bristol-Myers shareholder than from the sidelines.