Two signs that a company is focused on creating significant value for its shareholders are when the company boosts its dividend and when it repurchases its shares at attractive valuations.
Pharma stock Bristol Myers Squibb (BMY -0.08%) recently announced a 10.2% hike in its quarterly dividend to $0.54 per share. And if that wasn't enough to please shareholders, the company also authorized an additional $15 billion in share buybacks -- or nearly 11% of its $139 billion market capitalization.
This ambitious capital return plan raises two questions: Can the company afford it? And is the stock currently a buy? Let's dig into Bristol Myers Squibb's cash flow capabilities, balance sheet, and valuation to try to answer these questions.
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Bristol Myers Squibb is a cash flow machine
At the heart of Bristol Myers Squibb's tremendous capital return program for shareholders is the company's anticipated production of between $45 billion and $50 billion in cumulative free cash flow (FCF) for shareholders from 2021 through 2023. That's approximately a third of its market cap in free cash flow in just three years, which would be amazing. But because some companies tend to overpromise and underdeliver, let's delve into whether this forecast is grounded in reality, or the management team has been wearing rose-colored glasses.
For the first three quarters, Bristol Myers Squibb had generated $12.1 billion in operating cash flow against $653 million in capital expenditures. In just nine months, the company has provided $11.5 billion in free cash flow for shareholders. At the rate it's going, this would work out to $46 billion in free cash flow between 2021 and 2023. Bristol Myers Squibb is positioned to hit the low end of its FCF target before even considering another important lever that it can use to bump its free cash flow even higher.
That lever is its $13.5 billion cash position as of the most recent quarter. This gives Bristol Myers Squibb flexibility to execute the purchase of a medium-sized company if it believed such an acquisition target could fit well within its existing drug portfolio.
Bristol Myers Squibb's 2021 free cash flow easily covered its $3.5 billion in share buybacks executed and $3.3 billion in dividends paid during that time. Simply put, the company is a free cash flow monster capable of affording its market-beating 3.5% dividend yield and significant share repurchases.
The balance sheet is solid
Bristol Myers Squibb is throwing off more than enough free cash flow to fund its dividend and share repurchases. But could the state of its balance sheet force the stock to cut back on the dividend or on share repurchases?
The company's ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) is 2.2. Note that the company's EBITDA has varied wildly for more than a decade but the Q3 results are in line with its 13-year median of 2.2. While Bristol Myers Squibb's debt-to-EBITDA ratio is weaker than Johnson & Johnson's of 1.5, it's stronger than AbbVie's of 3.2.
Despite its generous capital allocation, Bristol Myers Squibb was able to reduce its long-term debt by $8.7 billion year-to-date (through Sep. 30, 2021), to $39.7 billion in the quarter. This indicates that the company can take a balanced approach to its dividend and share-repurchase activity, as well as to debt repayment.
Quality at a reasonable valuation
Bristol Myers Squibb appears to be a financially healthy business. But is it worth buying at the current valuation? Well, its forward price-to-earnings (P/E) ratio of 7.9 is considerably lower than the drug manufacturing industry average of 11.4. This implies that the stock could be an undervalued dividend growth stock for income investors.
Let's also weigh its growth prospects against its industry. The company's forecast 6% annual earnings growth over the next five years is moderately lower than the industry average of 10%. This justifies a somewhat lower valuation multiple until the company proves that it can overcome looming patent cliffs on its top three drugs -- Revlimid, Eliquis, and Opdivo.
However, if you're an income investor who believes Bristol Myers Squibb's pipeline will be sufficient to move past its current top-selling drugs, the current $63 share price would seem to provide a nice buying opportunity.
