Eli Lilly & Co. (NYSE:LLY) is one of Simons top picks, coming in as his 2nd largest 13F holding in 3Q. Sales are expected to be down slightly this year due to declining Zyprexa sales, which came off patent protection in 2011. One potential positive is the new drugs that are expected to carry Eli going forward, including its antidepressant (Cymbalta) and oncology agent (Alimta). The company’s pipeline is also robust, with over 65 compounds in R&D, and 13 drugs in phase III trials or under regulatory review.
Bristol Myers Squibb Co. (NYSE:BMY) is another one of Simons’ top pick, and was RenTech’s 4th largest holding last quarter. Bristol is down over 5% year to date as sales are expected to be down around 5% in 2013, as Plavix is now off patent protection. What has helped the pharma stock remain at the top of the valuation spectrum – as measured on a P/E and P/S basis – is its acquisition of Amylin Pharmaceuticals, and potential FDA approval of a new anticoagulant drug. Even with the recent acquisition that is expected to drive long-term growth, Amylin should dilute EPS by around 6 cents per share over the next two years.
When comparing the companies on a valuation basis, we find that both Glaxo and Eli are very much undervalued. Below are key multiples for our so-called “fab five”:
| Company | Price-to-Earnings | Price-to-Sales | Price-to-Cash Flow |
| Pfizer | 21x | 3.2x | 11x |
| Johnson & Johnson | 23x | 2.9x | 16x |
| GlaxoSmithKline | 14x | 2.4x | 14x |
| Eli Lilly | 14x | 2.4x | 10x |
| Bristol Myers | 30x | 2.9x | 20x |
Eli trades at the bottom of the industry on all three valuation measures and despite Glaxo’s relative cheapness, we find Eli’s growth prospects to be much more compelling. The company’s exposure to Europe, and the continued uncertainty of its economy is likely part of the reason for Glaxo’s bargain bin valuation. When looking at the two industry leaders, Johnson & Johnson and Pfizer, we see Pfizer as the best value play given its discounted price-to-cash flow multiple , and its very low forward P/E of 11x.
A big draw for investors is the high dividend yields of these pharma stocks amidst a low-rate environment. Below are key dividend metrics for our five:
| Company | Dividend Yield | Payout Ratio | 5-year Dividend Growth Rate |
| Pfizer | 3.4% | 68% | -5.4% |
| Johnson & Johnson | 3.5% | 76% | 8% |
| GlaxoSmithKline | 5.4% | 77% | 1.7% |
| Eli Lilly | 4.0% | 53% | 2.9% |
| Bristol Myers | 4.3% | 121% | 4.7% |
One of the cheapest pharma stocks, Glaxo, also pays the highest dividend yield at 5.4%. We still like Eli better given its lower payout ratio and solid dividend growth rate. Despite Johnson & Johnson’s leading dividend growth rate, we still like Pfizer’s opportunity to up its dividend yield, which can help it to outpace Johnson & Johnson in the interim. Pfizer’s recent realignment efforts, including raising cash through asset sales and IPOs, should be a fundamental driver of these dividend increases. We believe that Bristol’s valuation is too rich and would be cautious of its 120%+ payout ratio. Three of the five pharma stocks that Fisher and Simons love are also on our list of top ten pharma stocks loved by hedge funds. Here’s the entire list. Enjoy.
